Market Performance Implications of the Transfer Price Rule

We model the impact of the transfer price rule (a constraint that re- quires the downstream division of a vertically-integrated ?rm to earn at least a normal rate of return on investment in the counterfactual case that it pays the same price as a nonintegrated ?rm for the essential input), re- jected by the U.S. Supreme Court in Linkline, for the performance of markets in which an upstream ?rm provides an essential input to a down- stream ?rm with which it may compete in the retail market by vertical integration. We allow for horizontal and vertical product di¤erentiation in the ?nal good market. The upstream ?rm?s equilibrium distribution choice (between exclusion, dual distribution, or nonintegration) depends on relative product qualities. We characterize conditions under which the transfer price rule alters the upstream ?rm?s equilibrium distribution choice, and develop conditions for the transfer price rule to improve mar- ket performance.