Downstream Horizontal Integration and Dealer Network Performance

Abstract

A game theoretical model featuring a manufacturer and two dealers is proposed to investigate the effects of downstream horizontal integration on network performance. It is shown that the decision to integrate depends on both horizontal and vertical externalities. The manufacturer and dealers are mutually better off when integration leads to an increase in consumer demand through higher prices and better investments in services and national advertising. However, downstream integration harms the manufacturer's profit when the integrated dealer sets the price and service decisions in such a way as to free-ride on the manufacturer's brand. Surprisingly, under certain conditions, both the manufacturer and the dealers prefer downstream competition to integration regardless of whether it increases or reduces retail prices. The scenario in which the manufacturer prefers horizontal integration and the dealers opt for competition is not sustainable at the equilibrium. Mechanisms to implement horizontally integrated strategies such as the use of RPM and dealer cut are discussed.