Strategic profit sharing between firms: an apllication to joint ventures.

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(1)Working Paper 05-10 Economics Series 03 February 2005. Departamento de Economía Universidad Carlos III de Madrid Calle Madrid, 126 28903 Getafe (Spain) Fax (34) 91 624 98 75. STRATEGIC PROFIT SHARING BETWEEN FIRMS: AN APLLICATION TO JOINT VENTURES * Roberts Waddle 1. Abstract Our companion article developed a clear conceptual framework of profit sharing between two rival firms and studied the effects of this strategy on each firm's profit under the assumption that each firm decides unilaterally to give away voluntarily a part of its profit to its rival. This article relaxes totally this assumption and allows firms to invest rather a fraction of their profits in a joint venture. As in the previous article, it shows how and when forming a joint venture may be a successful strategy. Furthermore and more importantly, it brings to light that joint venture may be used to conceal the profit-sharing (maybe forbidden) strategy.. Key Words: Profit sharing, Oligopoly, Competition, Joint venture.. * Acknowledgements: We are grateful to our supervisor José Luis Ferreira Garcia for his numerous helpful suggestions and comments. Nevertheless, all remained errors are ours.. 1. Universidad Carlos III de Madrid, Madrid, Spain.E-mail: rwaddle@eco.uc3m.es.

(2) Strategic Pro…t Sharing Between Firms: An Application to Joint Ventures1 Roberts Waddle2 This version: 12 March 2005 Preliminary- Comments welcome! (please, do not circulate). 1 I’m. very grateful to my supervisor José Luis Ferreira for his numerous helpful suggestions. Nevertheless, all remained errors are my own. 2 Department of Economics, Universidad Carlos III de Madrid. Address: C/ Madrid 126; 28903 Getafe (Madrid), Spain. Tel: +34 91 624 8665. Fax: +34 91 624 9875. E-mail: rwaddle@eco.uc3m.es. Webpage: http://www.eco.uc3m.es/rwaddle.

(3) Abstract. Our companion article developed a clear conceptual framework of pro…t sharing between two rival …rms and studied the e¤ects of this strategy on each …rm’s pro…t under the assumption that each …rm decides unilaterally to give away voluntarily a part of its pro…t to its rival. This article relaxes totally this assumption and allows …rms to invest rather a fraction of their pro…ts in a joint venture. It thus shows how and when forming a joint venture may be a successful strategy. Furthermore and more importantly, it brings to light that a joint venture may be used to conceal the pro…t-sharing (maybe forbidden) strategy.. Keywords: Pro…t sharing, Oligopoly, Competition, Joint venture. JEL Classi…cation: C72, D21, L13, L24..

(4) 1. Introduction. In a companion paper (Waddle 2005b), we examined how sharing pro…ts may increase …rms’pro…ts in an oligopoly market. Our companion paper1 focused on such a strategy where both …rms unilaterally decides to give away a fraction of their pro…ts to their rivals. The purpose of this present paper is to relax totally this assumption and to allow …rms to invest rather a part of their pro…ts in a joint venture (henceforth JV). The rationale of relaxing that hypothesis is to overcome any eventual prohibition of this strategy. It thus shed light on how and when forming a JV may be a successful strategy. Furthermore and more importantly, it brings to light that a JV may be used to conceal the pro…t-sharing (maybe forbidden) strategy. Interestingly, this result holds for di¤erentiated markets too. The article proceeds as follows. Section 2 presents the model where …rms receive half the JV pro…t to show the existence of a multiplicity of NEa in prices. It then points out that …rms win by investing in a JV. Section 3 modi…es the model by allowing …rms to share the JV pro…t according to a "proportion rule". However, the result remains the same. As before, it highlights that invest in a JV is a winning strategy. Section 4 concludes.. 2. The model. We consider here a model similar to the one presented in our companion paper (Waddle 2005b) except that we allow …rms to invest (rather than to share) a part of their pro…ts to a joint venture. Let two …rms 1 and 2 in a homogeneous market and suppose that each …rm incurs a cost c per unit of production. The market demand function is q = D(p) = 1 p. We assume that …rms do not have capacity constraints and always supply the demand they face. Therefore, the pro…t function of …rm i is:. i. 8 < (pi c)qi 1 (pi c)qi = : 2 0. if if. pi < pj p i = pj i = 1; 2 (i 6= j) otherwise. where qi is the quantity demanded faced by …rm i. 1. See Waddle 2005b for a discussion of the relation between our work and the literature.. 1.

(5) Let 1 (resp. 2 ) denote the part of the pro…t that …rm 1 (resp. …rm 2) is willing to invest in the JV. We assume that i 2 [0; 1]. Since 1 1 + 2 2 is invested to the JV, we can suppose that the JV pro…t function is: f ( 1 1 ; 2 2 ) = ( 1 1 + 2 2 ) where > 0 is the technology of the JV production2 . Finally, we assume that each …rm receives half the JV pro…t3 . Consequently, we can write the new pro…t function Pi (pi ( i ; j ); pj ( i ; j )) (hereafter Pi ) of each …rm as: Pi = (1 Pi = 1. i). (1. i. + 12 f (. 1 2. ). i. 1 i. 1;. +. 1 2. 2). 2 j. = (1. i). i. +. 1 2. (. i. i. +. j. j). or. j. We consider a two-stage game whose sequences are thus de…ned. In the …rst stage of the game, …rms choose the optimal i to invest. In the second stage of the game, …rms select pi . In the …rst stage of the game, for. 1. and. 2. …rms simultaneously solve:. M ax. 1. P1 = 1. (1. 1 2. ). 1. 1. +. 1 2. 2. 2. M ax. 2. P2 = 1. (1. 1 2. ). 2. 2. +. 1 2. 1. 1. In the second stage of game, for p1 and p2 …rms simultaneously solve: M axp1. P1 = 1. (1. 1 2. ). 1. 1. +. 1 2. 2. 2. M axp2. P2 = 1. (1. 1 2. ). 2. 2. +. 1 2. 1. 1. 2 Note that the joint venture pro…t function, by analogy to the traditional macro production function, can be decreasing, constant or increasing return to scale whether is less, equal or greater than 1. 3 In the next section, we will relax this assumption by giving out the JV pro…t following a "proportion rule": i +i j. 2.

(6) 2.1. Solving the second-stage of the game. To …nd the subgame perfect Nash equilibrium (SPNE), we begin by solving subgames in the second-stage. Recall that, in the second stage, …rms are looking for prices that maximize their pro…ts. Proposition 1 If (1 12 ) 1 + 21 2 = 1 and (1 12 ) 2 + 12 1 = 1, then any prices (p1 , p2 ) such that c p1 = p2 pm are NEa in the second stage of the game Proof. (p1 , p2 ) such that c p1 = p2 pm are NEa if and only if no …rm wants to deviate from those prices by …xing a price p0i above or below. In fact: c. pm ). p1 = p2 = p 1. = 21 (p1. P1 = 1. 1 2. =. ). 1. +. 1 2. 0. 2. p1 ) = 12 (p. c) (1 (1. 1. c) (1. 2. p) =. 2. 1. P1 =. 1 2. 1. (1. 1 2. ). 1. +. 1 2. 2. (p. c) (1. p). P2 =. 1 2. 1. (1. 1 2. ). 2. +. 1 2. 1. (p. c) (1. p). Suppose that: " (" > 0) (). i) p1 = p2 P10 = 1 If p1. (1. 1 2. ). 1. 1. 1. = (1. = 1. p1 ) (p1 1 2. (1. ). 1. pm (monopolistic price), then p1 = p. For " very small4 , P10 ' 1 1. (1. 1 ) 2. (1. 1. ii) p1 = p2 + " (" > 0) (). 2. 1 2. ). 1. (1. 2. =0. p1 ) (p1. c). ".. (1. p) (p. 1 1 2. (1. = (1. p2 ) (p2. 4. c) and. 1 ) 2. 1. +. P1 ,. c) 1 2. (1). 2. c) > 0 and. 1. =0. There is no reason for not to suppose that " is very small. For instance, …rms need to decrease or increase just slightly to get or to lose the entire market.. 3.

(7) 1 2. P100 =. 2. =. 2. 1 2. 2. 1 2. 2. (1. p2 ) (p2 1 1 2. P1 ,. c) 1 ) 2. (1. +. 2. 1 2. (2). 1. Equations (1) and (2) represent the non-deviation conditions for …rms 1 and are both satis…ed when 1 (1 12 ) 1 = 21 2 or (1 12 ) 1 + 12 2 = 1. 1 2. Likewise, we can show that …rm 2 will not deviate if 1 1 ) 2 + 12 1 = 1. 1 or (1 2. (1. 1 2. ). 2. =. Conclusion: if (1 12 ) 1 + 12 2 = 1 & (1 12 ) 2 + 12 1 = 1, then any prices (p1 , p2 ) such that c p1 = p2 pm are NEa in the second-stage of the game. Proposition 2 If (1 12 ) 1 + 12 2 = 1 or (1 12 ) 2 + 12 1 = 1, then any prices (pi , pj ) such that c pi = pm < pj are NEa in the second stage of the game Proof. (p1 , p2 ) s. t. c p2 = pm < p1 are NEa if and only if no …rm has interest to deviate from those prices by …xing a price p0i above or below. A: P1 =. c 1 2. p2 = pm < p 1 ) 2. P2 = 1. 2. 1 2. = 1 2. (1. 2. ). (p2. 2. 2. = 0 and. 1. c) (1 = 1. 2. = (p2. c) (1. p2 ) > 0. p2 ) 1 2. (1. ). 2. (p2. c) (1. p2 ). Suppose that: " (" > 0) (). i) p1 = p2 P10 = 1. (1. 1 2. ). 1. = (1. 1. = 1. For " very small, P10 ' 1. (1. 1. 1. (1. p1 ) (p1 1 2. (1 1 2. 1 ) 2. ). 1. 1. ). 1. (1 <. c) and (1. 2. =0. p2 + ") (p2. p2 ) (p2 1 2. 2. ". c). c) < P1 , (3). Equation (3) represent the non-deviation conditions for …rm 1 and can be rewritten as: (1 21 ) 1 + 12 2 > 1 4.

(8) B:. c. p1 = pm < p 2 ). P1 = 1 P2 =. 1 2. 1 2. (1 1. 1. ) 1 2. =. 1 1. 1. = (p1. 1. = 1. (p1. 1 2. (1. c) (1. p1 ) and. c) (1 ). 1. (p1. 2. =0. c) (1. p1 ). p1 ). Suppose that: " (" > 0) (). i) p2 = p1 P20 = 1. 1 2. (1. ). 2. = (1. 2. = 1. For " very small, P10 ' 1. (1. 2. 1. (1. p2 ) (p2 1 2. (1 1 2. ). 1 ) 2. ) (1. 2. 2. 2. <. c) and (1. =0. p1 + ") (p1. ". c). c) < P1 ,. p1 ) (p1 1 2. 2. (4). 1. Equation (4) represent the non-deviation conditions for …rm 2 and can be rewritten as: (1 21 ) 2 + 12 1 > 1 Conclusion: if (1 12 ) 2 + 12 1 > 1 or (1 12 ) 1 + 12 2 > 1, then any prices (pi , pj ) such that c pi = pm < pj constitute NEa in the second-stage of the game. Proposition 3 If (1 21 ) 2 + 12 1 < 1 or (1 12 ) 1 + 12 2 < 1, then any price (p1 , p2 ) such that p1 = p2 = c is NEa in the second stage of the game Proof. (p1 , p2 ) s.t. p1 = p2 = c is NE if and only if no …rm has interest to deviate from those prices to …x a price p0i above or below. p2 = p2 = c ). 1. = 0 and. 2. =0. P1 = 1. (1. 1 2. ). 1. 1. +. 1 2. 2. 2. =0. P2 = 1. (1. 1 2. ). 2. 2. +. 1 2. 1. 1. =0. We shall study separately the deviation for both …rms. Let us check …rst for …rm 1. Suppose that: " (p1 < p2 and p1 < c) ). i) p1 = p2 P10 = 1. (1. 1 2. ). 1. 1. <0 5. 1. < 0 and. 2. =0.

(9) ) P10 < P1 = 0 )Firm 1 has no interest by …xing a price below p2 ii) p1 = p2 + " (p1 > p2 = c) () (…rm 1 does not produce) P100 =. 1 2. 2. 2. 2. = (1. c) = 0 and. p2 ) (p2. 1. =0. =0. P100 = 0 = P1 )Firm 1 has no interest by …xing a price above p2 Let us check now for …rm 2. Suppose that: " (p2 < p1 and p2 < c) ). i) p2 = p1 not produce) P20 = 1. 1 2. (1. ). 2. 2. 2. < 0 and. = 0 (…rm 1 does. 1. <0. ) P20 < P2 = 0 )Firm 2 has no interest by …xing a price below p1 ii) p2 = p1 + " (p2 > p1 = c) () (…rm 2 does not produce) P200 =. 1 2. 1. 1. 1. = (1. p1 ) (p1. c) = 0 and. 2. =0. =0. P200 = 0 = P2 )Firm 2 has no interest by …xing a price above p1 Conclusion: If (1 21 ) 2 + 12 1 < 1 or (1 12 ) 1 + 12 2 < 1, then any price, (p1 , p2 ) s.t.p1 = p2 = c is a NE in the second-stage of the game. The second-stage being entirely solved and NEa being found, we can thus move to the …rst-stage of the game in order to …nd SPNEa. 2.2. Solving the …rst-stage of the game. In the …rst-stage of the game, …rms choose the i optimal maximizing their pro…t to share with their rival. Solving backwards, we have solved the second-stage of the game in the previous section and have found NEa in prices summarized below5 : i) (p1 ; p2 ) = p1 = p2 = c if (1 with: 5. One can easily check that: if (1 then 12 1 (1 12 ) 1 + 12 2 = 3. 1 2. ). 1 2+ 2. 1 1 2 ) 2 + 2 1 2 (resp. 2. 6. 1. 1. 1. < 1 or (1. = 1 (resp (1 (1 12 ) 2 +. 1 2. 1 2. 1 2. ). 1 1+ 2. ). 1. 1. + 12 =3. 2. <1. 2. = 1). 1 )..

(10) P1 = 0 P2 = 0 1 2. ii) (p1 ; p2 ) = c 2 = 1 with: P1 = 3 P2 = 3. 1 2. (p 1 (p. c) (1 c) (1. 2. 1 2. i. (pm. 1. 1 2. 1 2. ). 2. +. 1 2. 1. = 1 & (1. 1 2. ). 1. +. 1 2. ). 2. +. 1 2. 1. > 1 or (1. 1 2. ). 1. +. p) p). pi = pm < pj if (1. iii) (p1 ; p2 ) = c 2 > 1 with: Pj = Pi = 1. pm if (1. p1 = p2. c) (1 pm ) c) (1 i (pm. pm ). Now, in the current section, we draw our attention to the …rst-stage of the game searching for SPNEa in i . Proposition 4 The strategies ( 1 ; p1 ( 1 ; 2 )), ( 1 ; p1 ( 1 ; 2 )) s.t.: i) 8i 2 ]0; 1[ & (1 12 ) 2 + 12 1 = 1 & (1 12 ) 1 + 12 2 = 1 p1 = p2 = c if (1 12 ) 2 + 12 1 < 1 or (1 12 ) 1 + 12 2 < 1 < p = p2 = pm if (1 12 ) 2 + 12 1 = 1 and (1 12 ) 1 + 12 2 = 1 ii) : 1 c pi = pm < pj if (1 21 ) 2 + 12 1 > 1 or (1 12 ) 1 + 12 2 > 1 are SPNEa of the game Proof. The strategies ( 1 ; p1 ( 1 ; 2 )), ( 1 ; p1 ( 1 ; 2 )) s.t. i) and ii) are satis…ed, are SPNEa if and only if no …rm has interest to deviate from those prices by choosing a 0i above or below. Because of the multiplicity of i , we investigate separately the deviation for each …rm. Let us check …rst for …rm 1. Suppose that: i). 0 1. <. 1. 1 2. ) (1. 0 1. ). +. 1 2. 2. <1). P10 = 0 < P1 = 3 ii). 0 1. >. P100 =. 1. ) (1. 1 2. 2. (pm. 1 2. ). 0 1. +. c) (1. 1 2. 2 2. (pm. c) (1. (5). pm ). >1). pm ) < P1 = 3. 2. (pm. c) (1. (5) and (6) show that …rm 1 has no interest to deviate. 7. pm ). (6).

(11) Now, let us check for …rm 2. Suppose that: 0 2. i). <. ) (1. 2. 1 2. ). 0 2. +. 1 2. 1. <1). P20 = 0 < P2 = 3 ii). 0 2. P200 = 1. >. ) (1. 2. 1. 1 2. 1 2. ) 0 2. 0 2. +. (pm. 1 2. 1 1. (pm. c) (1. (7). pm ). >1). c) (1. pm ) < P2 = 3. 1. (pm. c) (1. pm ) (8). (7) and (8) show that …rm 2 has no interest to deviate. Conclusion: The strategies ( 1 ; p1 ( 1 ; ii) are satis…ed, are SPNEa of the game.. 3. 2 )),. (. 1 ; p1. (. 1;. 2 )). s.t. i) and. The modi…ed model. We consider the same model as in the previous section except that we allow …rms to share the JV pro…t following a "proportion rule". As before, let two …rms 1 and 2 in a homogeneous market and suppose that each …rm incurs a cost c per unit of production. The market demand function is q = D(p) = 1 p. We still assume that …rms do not have capacity constraints and always supply the demand they face. Therefore, the pro…t function of …rm i is:. i. 8 < (pi c)qi 1 (pi c)qi = : 2 0. if if. pi < pj p i = pj i = 1; 2 (i 6= j) otherwise. where qi is the quantity demanded faced by …rm i. Let 1 (resp. 2 ) denote the part of the pro…t that …rm 1 (resp. …rm 2) is willing to invest to a JV. We assume that i 2 [0; 1]. Since 1 1 + 2 2 is invested to the JV, we can suppose that the JV pro…t function is: f ( 1 1 ; 2 2 ) = ( 1 1 + 2 2 ) where > 0 is the technology of the 6 JV production Finally, contrary to the last section, we assume that …rm 6. Note that the joint venture pro…t function, by analogy to the traditional macro production function, can be decreasing, constant or increasing return to scale whether is less, equal or greater than 1.. 8.

(12) i receives i +i j of the JV pro…t. For simplicity, let us denote Ci = i +i j , i = 1; 2 (i 6= j) Consequently, we can write the new pro…t function Pi (pi ( i ; j ); pj ( i ; j )) (hereafter Pi ) of each …rm as: Pi = (1. i). i+. i i+ j. or Pi = [1. (1. Ci ) i ]. f( i. 1. 1;. 2. 2). j. j. + Ci. = (1. i). i+. (. i i+ j. i. i. +. j. j). We consider a two-stage game whose sequences are thus de…ned. In the …rst stage of the game, …rms choose the optimal i to invest. In the second stage of the game, …rms select pi . In the …rst stage of the game, for. 1. and. 2. …rms simultaneously solve:. M ax. 1. P1 = [1. (1. C1 ). 1]. 1. + C1. 2. 2. M ax. 2. P2 = [1. (1. C2 ). 2]. 2. + C2. 1. 1. In the second stage of game, for p1 and p2 …rms simultaneously solve:. 3.1. M ax. 1. P1 = [1. (1. C1 ). 1]. 1. + C1. 2. 2. M ax. 2. P2 = [1. (1. C2 ). 2]. 2. + C2. 1. 1. Solving the second-stage of the game. To …nd the subgame perfect Nash equilibrium (SPNE), we begin by solving subgames in the second-stage. Recall that, in the second stage, …rms are looking for prices that maximize their pro…ts. Proposition 5 If (1 C1 ) 1 + C1 2 = 1 and (1 C2 ) 2 + C2 1 = 1, then any prices (p1 , p2 ) such that c p1 = p2 pm are NEa in the second stage of the game. 9.

(13) Proof. (p1 , p2 ) such that c p1 = p2 pm are NEa if and only if no …rm wants to deviate from those prices by …xing a price p0i above or below. In fact: c. pm ). p1 = p2 = p 1. = 21 (p1. P1 = [1. c) (1. (1. C1 ). 1. =. p1 ) = 12 (p 1. + C1. 0. 2. c) (1 2]. p) =. 2. 1. P1 = 12 [1. 1. +. 1 ] (p. c) (1. p). P2 = 21 [1. 2. +. 2 ] (p. c) (1. p). Suppose that: " (" > 0) (). i) p1 = p2 P10 = [1 If p1. (1. C1 ). 1]. 1. 1. = (1. = [1. c) and. p1 ) (p1. (1. C1 ). 1 ] (1. pm (monopolistic price), then p1 = p. For " very small7 , P10 ' [1 [1. (1. (1 C1 ). C1 ) 1]. ii) p1 = p2 + " (" > 0) (). 2. P100 = C1. p2 ) (p2. 2. 2. = C1. 2. (1. C1. 2. = (1. 1 [1 2. =0. p1 ) (p1. c). c). P1 ,. ".. 1 ] (1. 1 [1 2. p) (p 1. +. (9). 1]. c) > 0 and. p2 ) (p2. 1. =0. P1 ,. c) 1. 2. +. (10). 1]. Equations (9) and (10) represent the non-deviation conditions for …rms 1 and are both satis…ed when [1 (1 C1 ) 1 ] = C1 2 or (1 C1 ) 1 + C1 2 = 1. Likewise, we can show that …rm 2 will not deviate if [1 C2 1 or (1 C2 ) 2 + C2 1 = 1.. (1. C2 ). 2]. =. Conclusion: if (1 C1 ) 1 + C1 2 = 1 & (1 C2 ) 2 + C2 1 = 1, then any prices (p1 , p2 ) such that c p1 = p2 pm are NEa in the second-stage of the game. 7. There is no reason for not to suppose that " is very small. For instance, …rms need to decrease or increase just slightly to get or to lose the entire market.. 10.

(14) Proposition 6 If (1 C1 ) 1 + C1 2 = 1 or (1 C2 ) 2 + C2 1 = 1, then any prices (pi , pj ) such that c pi = pm < pj are NEa in the second stage of the game Proof. (p1 , p2 ) s. t. c p2 = pm < p1 are NEa if and only if no …rm has interest to deviate from those prices by …xing a price p0i above or below. A:. c. p2 = pm < p 1 ). P1 = C1 P2 = [1. 2. 2. (1. = C1 C2 ). 2. 1. = 0 and. (p2. 2]. c) (1. = [1. 2. 2. = (p2. c) (1. p2 ) > 0. p2 ). (1. C2 ). 2 ] (p2. c) (1. p2 ). Suppose that: " (" > 0) (). i) p1 = p2 P10 = [1. (1. C1 ). 1]. 1. = (1. = [1. 1. For " very small, P10 ' [1. (1. [1. (1. C1 ). C1 ). (1. C1 ). c) and. p1 ) (p1. 1 ] (1. 1 ] (1. 1]. =0. p2 + ") (p2. ". c). c) < P1 ,. p2 ) (p2. < C1. 2. (11). 2. Equation (11) represent the non-deviation conditions for …rm 1 and can be rewritten as: (1 C1 ) 1 + C1 2 > 1 B:. c. p1 = pm < p 2 ). P1 = [1 P2 = C2. (1 1. C1 ) 1. 1]. = C2. 1. = [1. 1 1. = (p1. (p1. c) (1. (1. C1 ). c) (1. p1 ). = (1. p2 ) (p2. p1 ) and 1 ] (p1. 2. =0. c) (1. p1 ). Suppose that: " (" > 0) (). i) p2 = p1 P20 = [1. (1. C2 ). 2]. For " very small, P20 ' [1 [1. 2. 2. = [1 (1 (1. (1. C2 ). C2 ) C2 ). 2]. c) and 2 ] (1. 2 ] (1. < C2. =0. p1 + ") (p1. p1 ) (p1 1. 2. ". c). c) < P1 , (12). Equation (12) represent the non-deviation conditions for …rm 2 and can be rewritten as: (1 C2 ) 2 + 21 1 > 1 Conclusion: if (1 C2 ) 2 + C2 1 > 1 or (1 C1 ) 1 + C1 2 > 1, then any prices (pi , pj ) such that c pi = pm < pj constitute NEa in the second-stage of the game.. 11.

(15) Proposition 7 If (1 C2 ) 2 + C2 1 < 1 or (1 C1 ) 1 + C1 2 < 1, then any price (p1 , p2 ) such that p1 = p2 = c is NE in the second stage of the game Proof. (p1 , p2 ) s.t. p1 = p2 = c is NE if and only if no …rm has interest to deviate from those prices to …x a price p0i above or below. p2 = p2 = c ). 1. = 0 and. P1 = [1. (1. C1 ). 1]. 1. + C1. 2. 2. =0. P2 = [1. (1. C2 ). 2]. 2. + C2. 1. 1. =0. 2. =0. We shall study separately the deviation for both …rms. Let us check …rst for …rm 1. Suppose that: " (p1 < p2 and p1 < c) ). i) p1 = p2 P10 = [1. (1. C1 ). 1]. 1. 1. < 0 and. 2. =0. <0. ) P10 < P1 = 0 )Firm 1 has no interest by …xing a price below p2 ii) p1 = p2 + " (p1 > p2 = c) () (…rm 1 does not produce) P100 = C1. 2. 2. 2. = (1. p2 ) (p2. c) = 0 and. 1. =0. =0. P100 = 0 = P1 )Firm 1 has no interest by …xing a price above p2 Let us check now for …rm 2. Suppose that: " (p2 < p1 and p2 < c) ). i) p2 = p1 not produce) P20 = [1. (1. C2 ). 2]. 2. 2. < 0 and. 1. = 0 (…rm 1 does. <0. ) P20 < P2 = 0 )Firm 2 has no interest by …xing a price below p1 ii) p2 = p1 + " (p2 > p1 = c) () (…rm 2 does not produce) P200 = C2. 1. 1. 1. = (1. p1 ) (p1. c) = 0 and. =0. P200 = 0 = P2 )Firm 2 has no interest by …xing a price above p1 12. 2. =0.

(16) Conclusion: If (1 C2 ) 2 + C2 1 < 1 or (1 C1 ) 1 + C1 2 < 1, then any price, (p1 , p2 ) s.t.p1 = p2 = c is a NE in the second-stage of the game. The second-stage being entirely solved and NEa being found, we can thus move to the …rst-stage of the game in order to …nd SPNEa. 3.2. Solving the …rst-stage of the game. In the …rst-stage of the game, …rms choose the i optimal maximizing their pro…t to share with their rival. Solving backwards, we have solved the second-stage of the game in the previous section and have found NEa in prices summarized below8 : i) (p1 ; p2 ) = p1 = p2 = c if (1 C1 2 < 1 with:. C2 ). 2. + C2. 1. < 1 or (1. C1 ). 1. +. C1 ). 1+. P1 = 0 P2 = 0 ii) (p1 ; p2 ) = c C1 2 = 1 with:. p1 = p2. P1 = 2 P2 = 2. c) (1 c) (1. (p 1 (p 2. pm if (1. C2 ). 2+. C2. 1. = 1 & (1. p) p). iii) (p1 ; p2 ) = c pi = pm < pj if (1 C1 ) 1 + C1 2 > 1 with: Pj = Cj i (pm c) (1 pm ) Pi = [1 (1 Ci ) i ] (pm c) (1. C2 ). 2. + C2. 1. > 1 or (1. pm ). Now, in the current section, we draw our attention to the …rst-stage of the game searching for SPNEa in i . Proposition 8 The strategies ( 1 ; p1 ( 1 ; 2 )), ( 1 ; p1 ( 1 ; 2 )) s.t.: i) 8i 2 ]0; 1[ & (1 C2 ) 2 + C2 1 = 1 & (1 C1 ) 1 + C1 2 = 1 p1 = p2 = c if (1 C2 ) 2 + C2 1 < 1 or (1 C1 ) 1 + C1 2 < 1 < p1 = p2 = pm if (1 C2 ) 2 + C2 1 = 1 & (1 C1 ) 1 + C1 2 < 1 ii) : c pi = pm < pj if (1 C2 ) 2 + C2 1 > 1 or (1 C1 ) 1 + C1 2 > 1 8. One can easily check that: if (1 C1 ) 1 +C1 2 = 1 (resp. (1 C2 ) then 21 [1 (1 C1 ) 1 + C1 2 ] = 2 2 (resp. 12 [1 (1 C2 ) 2 + C2. 13. 2 +C1. 1] = 2. 1. = 1) 1 )..

(17) are SPNEa of the game. Proof. The strategies ( 1 ; p1 ( 1 ; 2 )), ( 1 ; p1 ( 1 ; 2 )) s.t. i) and ii) are satis…ed, are SPNEa of the game.if and only if no …rm has interest to deviate from those prices by choosing a 0i above or below. Because of the multiplicity of i , we investigate separately the deviation for each …rm. Let us check …rst for …rm 1. Suppose that: 0 1. i). <. 1. ) (1. C1 ). 0 1. + C1. P10 = 0 < P1 = 2 ii). 0 1. >. 1. ) (1. P100 = C1. 2. (pm. 0 1. C1 ) c) (1. + C1. 2. <1). 2. (pm. c) (1. 2. >1). pm ) < P1 = 2. 2. (13). pm ). (pm. c) (1. pm ). (14). (13) and (14) show that …rm 1 has no interest to deviate. Now, let us check for …rm 2. Suppose that: i). 0 2. <. 2. ) (1. C2 ). 0 2. + C2. P20 = 0 < P2 = 2 ii). 0 2. P200 = [1. >. 2. (1. ) (1 C2 ). C2 ). 0 2. 0 2 ] (pm. + C2. 1. <1). 1. (pm. 1. >1). c) (1. c) (1. (15). pm ). pm ) < P2 = 2. 1. (pm. c) (1. pm ) (16). (15) and (16) show that …rm 2 has no interest to deviate. Conclusion: The strategies ( 1 ; p1 ( 1 ; ii) are satis…ed, are SPNEa of the game.. 14. 2 )),. (. 1 ; p1. (. 1;. 2 )). s.t. i) and.

(18) 4. Conclusion. This paper has shed light on how two …rms in a duopoly market may successfully form a joint venture. Furthermore and more importantly, it brings to light that a joint venture might be used to conceal the pro…t-sharing (maybe forbidden) strategy. Several extensions are readily suggested. The …rst and natural one is the extension of our analysis to more than two …rms. The second one is to consider di¤erent marginal costs. Finally, the third one is to move from the homogeneous market to an heterogeneous market. Such extensions should be straightforward. However, we leave them for future reasearch. 15.

(19) 5. References. [1] Waddle, R. (2005a) "Strategic Pro…t Sharing between Firms: I. A Primer" Universidad Carlos III, Working Papers, March. [2] Waddle, R. (2005b) "Strategic Pro…t Sharing between Firms: II. The Bertrand Model" Universidad Carlos III, Working Papers, March. [3] Waddle, R. (2005c) "Strategic Pro…t Sharing between Firms: III. An Application to Joint Ventures" Universidad Carlos III, Working Papers, March. [3] Waddle, R. (2005d) "Strategic Pro…t Sharing between Firms: IV. A Win-Win Strategy" Universidad Carlos III, Working Papers, March.. 16.

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