• *I am grateful to the Stockholm-based Knut and Alice Wallenberg Foundation for financial support. Research was initially performed at the Stockholm School of Economics. This paper has benefited from two thorough anonymous referee reports and helpful comments from the Editor, Jan Boone, Paolo Casini, Eirik N. Christensen, Tore Ellingsen, Chiara Fumagalli, Tim Howington, Chloé Le Coq, Stefan Napel, Per B. Overgaard, Lars Persson, Marcus Salomonsson, Jörgen Weibull, Bert Willems as well as conference participants at the XXII Jornadas de Economia Industrial (Barcelona, 2006), IIOC (Savannah, 2007), 1st RNIC conference (Mannheim, 2007), NORIO VI (Stockholm, 2007) and seminar audiences at Maastricht University, Tilburg University and HEC Montréal. Any remaining errors or shortcomings are mine alone.


In the case of vertically differentiated products, Bertrand competition at the retail level does not prevent an incumbent upstream firm from using exclusivity contracts to deter the entry of a high-quality rival. Indeed, because of differentiation, the incumbent's inferior product is not eliminated upon entry. Due to the resulting competitive pressure, a retailer who considers rejecting the exclusivity contract expects to earn much less than the incumbent's monopoly rents. Thus, in equilibrium, the incumbent can always offer high enough an upfront payment to induce all retailers to sign the contract and achieve exclusion. This is true under linear pricing for intermediate levels of entry costs, and with two-part tariffs even in the absence of entry costs.