Incentives for the emergence of vertical restraints.

Abstract

The incentive that an upstream firm has to integrate or to impose vertical restraints arises because the actions taken in the downstream market affect upstream profits. In this dissertation, the existence of an incentive to impose vertical restraints is studied experimentally and the use of exclusive dealing as a vehicle for monopolization is considered both theoretically and empirically. The first chapter investigates the presence of a vertical externality, and therefore an incentive to impose vertical restraints, in eleven experimental markets. The upstream markets are characterized by a single seller. When the downstream market consists of three firms, no evidence of a vertical externality is found, and prices and profits are consistent with the vertically integrated outcome. When the downstream market is characterized by a single firm, there is evidence of a vertical externality. An analysis of individual market behavior reveals that downstream firms approximate their best response functions, with some indication that they improve over time. The second chapter is a theoretical examination of the use of exclusive dealing to obtain monopoly power when the products are systems of goods with a vertically differentiated component. Two upstream firms sell the differentiated component directly to the consumers and the other components through a set of downstream firms. Conditions under which each firm will be able to monopolize the market using exclusive dealing are determined. The effect on prices is also examined. The third chapter is a case study of the U.S. home video game industry. Nintendo of America, Inc. used exclusive dealing contracts with the software companies that designed games for its system. These companies were prevented from selling games made for Nintendo in any other format. The claim that Nintendo achieved and maintained its virtual monopoly through the use of these contracts even though its console was of a lower quality than those of its competitors, is investigated using industry data and the model from Chapter 2. According to the model, conditions in the industry were such that Nintendo would have been able to maintain monopoly control, causing the higher quality firm to exit.