Abstract
Funlagalli and Motta (forthcoming) show that in the case of a homogenous product, competition at the retail level prevents an incumbent upstream firm from using exclusivity contracts in order to deter the entry of a more efficient rival. We show here that in the case where the upstream firms sell vertically differentiated products, the result is reversed: Bertrand competition among retailers makes it easy for an incumbent to exclude a higher-quality producer. Indeed, as long as the quality differential is not too large, the incumbent's inferior product cannot be priced out of the market. As a result of the ensuing price competition, the potential entrant is not assured to capture all the efficiency gains from the introduction of its superior product and decides not to enter unless it has access to both retailers. Since, by assumption, it cannot commit to transfer some of its profit to retailers in that event, exclusion emerges as the unique equilibrium outcome.