Costs and Benefits of Inducing Intrabrand Competition: The Role of Limited Liability

When is inducing intrabrand competition via nonexclusive distribution an optimal strategy? To address this issue, a static model is developed to examine two settings. The manufacturer uses exclusive distributors in the first setting and nonexclusive distributors in the second. The analysis indicates that the choice of distribution rests critically on whether the manufacturer can effectively extract surplus from the distributors. Due to a variety of institutional reasons, the distributors' liability is often limited in performing on behalf of the manufacturer; such limited liability restricts how much of the distributors' surplus can be extracted. When the distributors' surplus cannot be fully extracted, the manufacturer may prefer nonexclusive distribution even when distributors can free-ride on each other's efforts.