Endogenous competition mode with a common supplier

Abstract

We analyze the endogenous choice of competition mode by introducing a common supplier into a vertical structure. Contrary to previous findings, we derive that when choosing a competition mode, firms consider two opposing factors: (i) the horizontal effect arising from competition with a rival firm, and (ii) the vertical effect, which influences the price charged by the common supplier. When the common supplier adopts uniform pricing, if the both products are somewhat differentiated, the vertical effect becomes more important than the horizontal effect, making the price contract the dominant strategy. On the other hand, if the products are sufficiently homogeneous and the horizontal effect is more important than the vertical effect, both firms will choose a quantity contract. Meanwhile, when the common supplier adopts discriminatory pricing, choosing a quantity contract becomes the unique equilibrium. Finally, if the both products are somewhat differentiated, each firm's profit is higher under price competition than under quantity competition.