Strategic Vertical Market Structure and Opaque Products

Posted by D. Daniel Sokol

Mariano E. Tappata, University of British Columbia - Sauder School of Business, offers his thoughts on Strategic Vertical Market Structure and Opaque Products.

ABSTRACT: This paper studies opaque intermediation in differentiated product markets. We endow a circular city model with an intermediary that sells lotteries (opaque goods) over goods produced upstream. Compared to the benchmark model (Salop, 1979), opaque intermediation increases the intensity of price competition. However, it can be a profitable vertical market structure. Furthermore, it increases welfare and expands the range of entry costs supported by the industry. The emergence of opaque intermediation in established industries can be rationalized in the presence of seasonal demand such that the lower profits through increased competition when demand is high are outweighed by the benefits from expanding the extensive margin when demand is low.