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We consider a monopolistic supplier’s optimal choice of wholesale tariffs when downstream firms are privately informed about their retail costs. Under discriminatorypricing, downstream firms that differ in their ex ante distribution of retail costs are offered different tariffs. Under uniform pricing, the same wholesale tariff is offered to all downstream firms. In contrast to the extant literature on thirddegree price discrimination with nonlinear wholesale tariffs, we find that banning discriminatory wholesale contracts—the usual legal practice in the EU and US— often is beneficial for social welfare. This result is shown to be robust even when the upstream supplier faces competition in the form of fringe supply.

We analyze third degree price discrimination by an upstream monopolist to a continuum of heterogeneous downstream firms. The novelty of our approach is to recognize that customizing prices may be costly. As a consequence, partial price discrimination arises in equilibrium; in particular, we show that inefficient downstream firms receive personalized prices whereas efficient firms are charged a uniform price. The extreme cases of complete price discrimination and uniform price arise in our setting as particular cases, depending on the cost of customizing prices. Financial support from SEJ 2004-02172, SEJ 2007-67895, SEJ 2007-62656, FEDER funds and the IVIE is gratefully acknowledged.

An upstream supplier that is constrained both by downstream competition and the threat of demand-side substitution faces a tradeoff between maximizing joint-profit and extracting surplus. Although joint-profit maximization calls for relatively high marginal wholesale prices in order to dampen intra-brand competition, surplus extraction will be higher when the supplier instead charges relatively low marginal wholesale prices. The reason is that by inducing more intra-brand competition through lower wholesale prices, the supplier makes it less attractive for downstream firms to switch to alternative sources of supply. We show how this can make it optimal for the supplier to disadvantage more efficient and thus ultimately larger buyers, thereby smoothing out differences in their market shares. We further show that despite the use of non-linear supply contracts, marginal wholesale prices and thus final goods’ prices will decrease when either downstream competition intensifies or the supplier becomes more constrained by the threat of demand-side substitution.

Salant et al. (1983) showed in a Cournot setting that horizontal mergers are unprofitable because outsiders react by increasing their output. We show that this negative effect may be compensated by the positive effect that horizontal mergers have on the buyer power of merging firms in input markets.