Product Differentiation and Collusion Sustainability When Collusion is Costly

A widely debated question in recent years by both strategy theorists and antitrust practitioners is what role differentiation between firms plays in their ability to sustain a collusive agreement in order to reduce the strength of competition and gain higher profits. This paper addresses the following question: What happens to the product differentiation-collusion relationship when setting up and maintaining an agreement is costly? We show that introducing collusion costs into the discussion has relevant implications. Indeed, sufficiently high collusion costs modify the underlying market structure, thus altering the differentiation-collusion sustainability relationship with respect to the case where collusion costs are absent or low. In particular, if the gains from collusion are increasing (decreasing) with the degree of differentiation, the relationship between differentiation and collusion sustainability is always positive (negative), whereas if the gains from collusion are inverted U-shaped, the relationship is inverted U-shaped too. These results stress the importance of considering those markets where the coordination between firms is sufficiently costly as structurally different from those markets where coordination has no costs for firms.