Market-Share Contracts with Vertical Externalities

Abstract We construct a model of market-share contracts with vertical externalities. When a dominant supplier offers a linear wholesale price to a retailer, vertical externalities, well-recognized as double-marginalization problems, arise in the vertical relation. The dominant supplier facing vertical externalities charges a wholesale price that is excessively high for both the vertical relation and social welfare. Under market-share contracts, the retailer can commit to increase the sales of goods produced by the dominant supplier for a lower wholesale price. We point out that this induces the vertical relation to engage in market-share contracts even in the absence of exclusionary effects in the upstream market. We also show that such contracts mitigate vertical externalities and improve social welfare.