Cartel formation through strategic information leakage in a distribution channel

This paper studies the ability of competing retailers to form a cartel by sharing information with their mutual manufacturer. In a market characterized by demand uncertainty, colluding retailers wish to share information about the potential market demand to coordinate on the optimal collusive retail price. However, in light of potential exposure to antitrust investigations and possible sanctions, the retailers search for mechanisms to exchange information while avoiding the risks of scrutiny by the antitrust authorities. This paper examines such a mechanism: each retailer shares his private information with the mutual manufacturer; the wholesale price set by the latter is thereafter used by the retailers to infer the market condition and coordinate on the cartel’s price. Although a cartel at the retail level limits the manufacturer’s sold quantity, under certain conditions the manufacturer is better off accepting the retailers’ private information, thereby assisting the cartel formation. Moreover, vertical information sharing between the retailers and their mutual manufacturer can result in lower consumer surplus than that would have occurred had the retailers been permitted to collude directly.