Strategic Vertical Separation

The paper explores incentives for strategic vertical separation of \u85rms in a framework of a simple duopoly model. Each \u85rm chooses either to be a retailer of its own good (vertical integration) or to sell its good through an independent exclusive retailer (vertical separation). In the latter case a two-part tari ¤ is applied. Retailers compete in quantities, goods are perfect substitutes and \u85rms cost functions are quadratic. I show that the equilibrium outcome crucially depends on the degree of (dis)economies of scale and asymmetry of costs. Two asymmetric equilibria arise, in which one \u85rm separates while another integrates, under conditions that both \u85rmscost functions exhibit a su ¢ ciently high diseconomies of scale, or extreme asymmetry of costs. Under a moderate asymmetry of costs a unique equilibrium exists in which the \u85rm with the lower degree of diseconomies of scale separates, while its rival integrates. With the degree of iseconomies of scale low for both \u85rms in the unique equilibrium both \u85rms separate. JEL classi\u85cation: L22; L4