On the benefits of contractual inefficiency in quality-differentiated markets

Contractual inefficiencies within supply chains increase an input price above its marginal cost, therefore they are considered detrimental to consumer surplus. We argue that such inefficiencies may be beneficial to consumers in quality- differentiated markets. Indeed, enhancing contractual efficiency in high-quality supply chains may adversely affect the market structure by driving low-quality vertical chains out of the market and consequently reduce consumer surplus. Due to the finiteness property, (counter-)integration in the low-quality channel does not allow this channel to be in business. Our result holds irrespective of whether the contractual inefficiencies originate from the double marginalization or the ‘commitment effect’.