Price and Non-Price Restraints When Retailers are Vertically Differentiated

We consider vertical restraints in the context of an intrabrand competition model in which a single manufacturer deals with two vertically differentiated retailers. We establish two main results. First, if the market cannot be vertically segmented and the cost difference between the two retailers is not too large, then the manufacturer will foreclose the low quality retailer either directly by making the high quality retailer an exclusive distributor, or indirectly by imposing a sufficiently high minimum resale price, or a sufficiently high franchise fee to ensure that the low quality retailer will be unable to earn a positive profit. Second, if the market can be vertically segmented, the manufacturer will impose customer restrictions and require the low quality retailer to serve consumers whose willingness to pay for quality is below some threshold and requiring the high quality retailer to serve consumers whose willingness to pay for quality is above that threshold. We show that this restriction benefits the manufacturer as well as consumers with low willingness to pay for quality, including some that are served by the high quality retailer, but it harms consumers with high willingness to pay