Wholesale Price Determination Under the Threat of Demand-Side Substitution

32 Pages Posted: 14 Feb 2014

See all articles by Roman Inderst

Roman Inderst

Goethe University Frankfurt

Greg Shaffer

University of Rochester - Simon Business School

Date Written: October 2011

Abstract

An upstream supplier that is constrained both by downstream competition and the threat of demand-side substitution faces a tradeoff between maximizing joint-profit and extracting surplus. Although joint-profit maximization calls for relatively high marginal wholesale prices in order to dampen intra-brand competition, surplus extraction will be higher when the supplier instead charges relatively low marginal wholesale prices. The reason is that by inducing more intra-brand competition through lower wholesale prices, the supplier makes it less attractive for downstream firms to switch to alternative sources of supply. We show how this can make it optimal for the supplier to disadvantage more efficient and thus ultimately larger buyers, thereby smoothing out differences in their market shares. We further show that despite the use of non-linear supply contracts, marginal wholesale prices and thus final goods’ prices will decrease when either downstream competition intensifies or the supplier becomes more constrained by the threat of demand-side substitution.

Keywords: Vertical control, Input markets, Price discrimination, Buyer power

Suggested Citation

Inderst, Roman and Shaffer, Greg, Wholesale Price Determination Under the Threat of Demand-Side Substitution (October 2011). Available at SSRN: https://ssrn.com/abstract=2395274 or http://dx.doi.org/10.2139/ssrn.2395274

Roman Inderst (Contact Author)

Goethe University Frankfurt ( email )

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Germany
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HOME PAGE: http://www.wiwi.uni-frankfurt.de/en/departments/finance/lehrstuhl/prof-dr-roman-inderst/team

Greg Shaffer

University of Rochester - Simon Business School ( email )

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