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We study the incentives of a dominant firm to adopt market-share contracts (MSC) to compete with a small rival. We focus on a simple class of MSC which specifies a per-unit price conditional on the share of the buyer’s purchase from the firm over the total purchase satisfying a minimum threshold. The timing of the game is as follows: the dominant firm offers an MSC first, and then its rival offers a per-unit price. After seeing both offers, the buyer decides whether to accept the MSC and obey its market-share requirement, or to reject the MSC and single-sources from the rival firm. We characterize the subgame-perfect equilibrium outcome of this game as the solution to a constrained maximization problem. We show existence of equilibrium and provide a necessary condition for a 100%-exclusivity contract to be at the equilibrium. We further discuss the welfare implications of the equilibrium outcome.

The incentives of using MSC can be illustrated using a class of linear demand systems and depend on two economic factors: the product substitutability between the two firms and the dominant firm’s competitive advantage over its rival. We find that, with the degree of product substitutability given, the equilibrium MSC is a 100%-exclusive contract if and only if the dominant firm’s competitive advantage is sufficiently large. On the other hand, the equilibrium involves simple linear pricing when the dominant firm’s competitive advantage is sufficiently small. Product substitutability decreases the dominant firm’s incentives to use a less-than-100% MSC. The smaller the degree of product substitutability, the larger the competitive advantage is required to justify the full exclusivity.

Biography:

Guofu Tan is currently a Professor of Economics at the University of Southern California. He holds a PhD in economics from the California Institute of Technology. He previously taught at the University of British Columbia and the Hong Kong University of Science and Technology for many years and held the T.D. MacDonald Chair in Industrial Economics at the Competition Bureau in Canada from 2000 to 2001. He has also visited Tsinghua University, Cheung Kong Graduate School of Business, and Shanghai University of Finance and Economics.

Professor Tan’s research focuses on business strategy and industrial organization, competition and regulatory policies, auction theory, and microeconomics with applications. His research work has been published in leading scholarly journals such as the American Economic Review, Econometrica, Review of Economic Studies, RAND Journal of Economics, Journal of Economic Theory, International Journal of Industrial Organization, as well as many others. In the areas of business strategies, antitrust and regulatory policies, Professor Tan has advised a number of public and private clients, especially on matters involving merger reviews and abuse of dominance. Professor Tan has testified as an expert witness in court.