Bertrand vs. Cournot competition in distribution channels with upstream collusion

This paper applies repeated game theory to tacit collusion in dynamic distribution channels based on the grim trigger strategy. We examine competitors' choice of the strategic instruments in distribution channels comprised of two manufacturers distributing through two independent retailers respectively. First, the paper discusses the upstream manufacturers' collusion incentives under different competition modes for downstream retailers and shows that the manufacturers' collusion incentives critically depend on the retailers' competition modes and the discount factor. We then identify the endogenous competition modes in equilibrium. We find that upstream collusion is easier to sustain under Cournot competition than Bertrand competition, and it is least likely to be sustained under mixed Bertrand-Cournot competition. Furthermore, in equilibrium, retailers can engage in Bertrand, Cournot, or mixed Bertrand-Cournot competition, depending on the discount factor and the degree of product differentiation. This study provides the rationale behind the emergence of various modes of competition in practical dynamic distribution channels, especially the recent mixed Bertrand-Cournot competition mode. Finally, the manufacturers' collusion incentives and retailers' competition modes jointly affect the manufacturers' profitability and social welfare. We also discuss how the manufacturers' profitability and social welfare vary under different competition modes taking upstream collusion into consideration. We find that upstream collusion increases (decreases) social welfare for complements (substitutes).