Access Price and Vertical Control Policies for a Vertically Integrated Upstream Monopolist when Sabotage is Costly

Abstract

Input price and novel vertical control regulations are derived for a vertically integrated upstream monopolist when the monopolist can engage in non-price discrimination against a downstream rival. The paper extends the literature on sabotage in network industries by characterizing welfare-optimal regulatory policy with a realistic set of policy tools when sabotage can be undertaken, at a cost, by a monopoly access provider who also competes in a differentiated products Bertrand retail duopoly. Welfare optimal regulation balances the conflicting goals of reducing non-price discrimination and stimulating efficient production levels downstream. The regulator can induce the rst best in limited cases when the downstream rival is efficient relative to the downstream affiliate of the monopoly access provider, non-price discrimination by the integrated monopolist is sufficiently costly and downstream competition is not too intense. Otherwise, the regulator faces a trade-off between reducing the double markup problem by pricing access low while imposing restrictions on the control the monopoly input provider can exercise over its retail affiliate, versus pricing access high and allowing unrestricted vertical control within the vertically integrated rm in order to deter non-price discrimination. Discrimination costs and competition intensity determine which policy is optimal.