Profitable Double Marginalization

Posted by Social Science Research Network

Profitable Double Marginalization

Kevin Bryan (University of Toronto) & Erik N. Hovenkamp (Northwestern University)

Abstract:     When producers of complementary products set markups noncooperatively, they create a double marginalization problem. There is a longstanding consensus that this reduces the firms’ joint profits. On the contrary, we show that it will inadvertently raise (or even maximize) joint profits in many familiar competitive environments by facilitating credible yet imprecise commitment. This can occur even if the firms transact through noncooperative linear pricing, which is not susceptible to the credibility critique of the strategic delegation literature. Double marginalization is intimately related to other familiar behavior-distorting practices, such as vertical restraints and delegation. Any such distortion maximizes joint profits by making the downstream firm behave as if it has, in the language of conjectural variation, a “consistent conjecture,” meaning the firm is made to internalize strategic effects. A consequence is that upstream competition can induce a consistent conjectures equilibrium (CCE), evincing a strong link between ordinary “Nash games” and the CCE concept.