Endogenous vertical structure with network externalities

DongJoon Lee, Kangsik Choi and Tatsuhiko Nariu

Manchester School, 2020, vol. 88, issue 6, 827-846

Abstract: This study examines the endogenous vertical structure in which each manufacturer sells its product to its exclusive retailer who sells network goods to consumers (i.e. a duopoly in the upstream market) under Bertrand competition and Cournot competition with network externalities. We show that with strong (weak) network externalities under Bertrand competition, (a) it is a dominant strategy for each manufacturer to integrate (separate) its retailer; (b) with strong network externalities, the manufacturers’ profits, consumers’ surplus and social welfare are higher under vertical integration than under vertical separation. Under Cournot competition, (a) vertical separation is a unique subgame perfect Nash equilibrium; (b) with strong network externalities, the manufacturers’ profits, consumers’ surplus and social welfare are higher under vertical separation than under vertical integration.

Date: 2020
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