DP11220 You Are Judged by the Company You Keep: Reputation Leverage in Vertically Related Markets

Author(s): Jay-Pil Choi, Martin Peitz
Publication Date: April 2016
Keyword(s): Adverse Selection, Barriers to Entry, Branding, Certification Intermediaries, Experience Goods, Incumbency Advantage, Outsourcing
JEL(s): D4, L12, L4, L43, L51, L52
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11220

This paper analyzes a mechanism through which a supplier of unknown quality can overcome its asymmetric information problem by selling via a reputable downstream firm. The supplier's adverse-selection problem can be solved if the downstream firm has established a reputation for delivering high quality vis-à-vis the supplier. The supplier may enter the market by initially renting the downstream firm?s reputation. The downstream firm may optimally source its input externally, even though sourcing internally would be better in terms of productive efficiency. Since an entrant in the downstream market may lack reputation, it may suffer from a reputational barrier to entry arising from higher input costs.