Cooperation among competitors: A comparison of cost-sharing mechanisms

- We model two firms sharing a joint expenditure and competing on price or quantity.
- We compare outcome-based vs. ex ante-based cost-sharing mechanisms.
- Profit may be lower under quantity-proportional than ex ante-based mechanism.
- Conventional belief suggests that outcome-based mechanisms hurt the total welfare.
- We show that outcome-based mechanisms can actually enhance the total welfare.

In this paper, we investigate the consequences of using outcome-based versus ex ante-based cost-sharing mechanisms in terms of competing firms' profitability and total welfare. We consider two firms making a joint expenditure, which can positively affect firms' demand and/or unit operating costs, while competing in the final market by setting either price or quantity. We compare two outcome-based cost-sharing mechanisms, i.e., Quantity Proportional (QP) and Total Margin proportional (TM), with the more competitive Fixed Share (FS) mechanism where cost-sharing is set up on an ex ante basis. We show that outcome-based mechanisms, and even a fully collusive behavior induced by the optimal cost-sharing mechanism, might actually enhance total welfare as compared with the more competitive FS mechanism. We also find that, although the FS mechanism is never more preferable than the TM mechanism, it can lead to higher profits than the QP mechanism when competition is mild. These results can support firms cooperating with competitors in the choice of the cost-sharing mechanism as well as provide important implications to policy makers.