Working Papers in Economics,
University of Bergen, Department of Economics

Abstract: We study a setting where the opportunism or commitment problem identifed by Hart and Tirole (1990) may arise. An upstream monopolist may sell its product to two differentiated downstream retailers. Contract unobservability induces the manufacturer and each retailer to free-ride on margins earned by rival retailers, resulting in low transfer prices and low overall profit. O'Brien and Shaffer (1992) proposed a solution to this problem involving squeezing retail margins by using maximum RPM and high transfer prices. We show that when retail demand depends in any degree of retail sales effort, this equilibrium breaks down, and the opportunism problem reappears with full force. We show that no type of own-sale contracts or combination of own-sale restraints will solve the problem if sales effort matter. Moreover we show that certain horizontal commitments, as for example industrywide minimum RPM, may restore the fully integrated outcome, but only in special cases.

Keywords: Opportunism; RPM; sales effort

JEL-codes: L12; L14; L42

28 pages, October 18, 2013

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