Daniel P. O’Brien and Greg Shaffer

Credibility and Monitoring: Outsourcing as a Commitment Device

We examine how the feasibility of both nonlinear pricing and exclusive dealing arrangements affect incentives for market foreclosure when two manufacturers contract with a retail monopolist. Surprisingly, we find that although market foreclosure equilibria exist, they are Pareto-dominated (from each manufacturer’s perspective) by all nonforeclosure equilibria. If one believes that Pareto-dominated equilibria are unlikely to arise, then the difference between our results and those of Mathewson and Winter (1987), who do not allow for nonlinear pricing, suggests an ironic twist on the notion that quantity discounts and other kinds of nonlinear pricing can provide an additional way for a manufacturer to foreclose a rival. By providing a manufacturer with increased flexibility (beyond linear pricing) to extract a retailer’s surplus, nonlinear pricing may instead have the effect of reducing the incidence of observed market foreclosure.