Quantity Competition When Most Favored Customers are Strategic

Legal studies usually treat a policy of a manufacturer or retailer as socially harmful if it reduces product output and increases the price. We consider a two-period model where the first-period price is fixed and resellers endogenously decide to use meet-the-competition clause with a most-favored-customer clause (MFC) to counteract strategic customer behavior. As a result of MFC, the second-period (reduced) price increases and resellers’ inventories decrease. However, customer surplus may increase and aggregate welfare increases in the majority of market situations. MFC can mitigate the losses in welfare and resellers’ profits due to strategic customers. Moreover, under reseller competition, MFC may even lead to higher levels of these values than with myopic customers, that is, to gain from increased strategic behavior. With growing competition, benefits or losses from MFC can be higher than losses from strategic customer behavior.