Three Essays on Vertical Product Differentiation: Exclusivity, Non-exclusivity and Advertising

Abstract

Since Hotelling's (1929) seminal work, economists have tried to understand how product differentiation affects price competition. I study the product location decisions, on a vertical characteristic space, of two sets of horizontal competitors when the inputs supplied by the "upstream" set (the manufacturers) and the input supplied by the "downstream" set (the retailers) are combined one-to-one to form a final good under the assumption that each manufacturer sells through one retailer exclusively. I find that the final product provided by each manufacturer-retailer pair shows maximum differentiation along one dimension and minimum differentiation along the other (MaxMin equilibrium). I conduct the same analysis under the assumption that each manufacturer sells to any retailer and each retailer buys from any manufacturer. I find a Nash Equilibrium in which each firm differentiates its product completely from its horizontal competitor. Finally, I estimate the effect of advertising on consumer brand choice and search behavior. Under imperfect information, advertising can affect consumer behavior by providing economically relevant information in a convenient way. I find that advertising has an increasing effect on consumers' search effort and on the probability of purchase associated with the featured brand.