Vertical Separation with Private Contracts

We consider a manufacturer’s incentive to sell through an independent retailer, rather than directly to final consumers, when contracts with retailers cannot be observed by competitors. If retailers conjecture that identical competing manufacturers always offer identical contracts (symmetric beliefs), manufacturers choose vertical separation in equilibrium. Even with private contracts, vertically sep-arated manufacturers reduce competition and increase profits by inducing less aggressive behaviour by retailers in the final market. Manufacturers profits may be higher with private than with public contracts. Our results hold both with price and with quantity competition and do not hinge on retailers beliefs being perfectly symmetric. We also discuss various justifications for symmetric beliefs, including incomplete information. Can competing manufacturers obtain higher profits by delegating retail decisions to independent agents, rather than selling directly to final consumers? Manufacturers jointly benefit from high retail prices but, when they sell directly to final consumers, competition among them results in low prices and profits. However, a manufacturer can induce an independent retailer to sell at higher prices, by charging a wholesale price higher than marginal cost. And credibly committing to doing so has a strategic effect on rival retailers, who react by selling at higher prices themselves, thus reducin