Vertical Relations and Dynamic Exclusion of Product Improvement

We consider infinitely repeated vertical relations when a retailer can sell an established product and a new product that is initially inferior but can improve over time. We find that the retailer has an incentive to sell the new product more than what maximizes industry profits. The manufacturer of the established product excludes the new product by setting a below-cost wholesale price, combined with a fixed fee, in all periods, and accommodates the new product more than under vertical integration. If exclusive dealing is allowed, the manufacturer imposes it and replicates the vertically integrated outcome. Such exclusive dealing can either increase or decrease social welfare