Optimal Tariffs with Uncertainty and Downstream Fixed Costs

We consider an upstream firm dealing with a downstream firm either via a two-part tariff or a linear tariff. The downstream firm faces demand uncertainty, it is risk-averse, and it must incur a fixed cost before demand realization. We show that when the fixed cost is relatively high, it is optimal for the supplier to subsidize part of it: such subsidization corresponds to a two-part tariff with negative fixed fee. In such case, the two-part tariff creates a stronger double-margin distortion than the linear tariff (no-subsidization scheme), and thus generates lower consumer surplus and total welfare