Advantages and disadvantages of Keiretsu transactions and Business to Business auctions

We construct a simple model with upstream firms and downstream firms and compare a Keiretsu transactions prevailed in Japan and business to business (BtoB) auctions from the view points of consumers, firms, and society as a whole. Each of the upstream firms produces a homogeneous product and each of the downstream firms uses it as its input. Downstream firms produce the homogeneous final goods and compete a la Cournot. Under this setting, we compare the two market structures. Firstly, an upstream firm and a downstream firm engage in an exclusive relationship. Vertical integration and ‘Keiretsu’ are examples. Secondly, upstream firms and downstream firms engage in a nonexclusive relationship such as open auctions. BtoB commerce is an example and we focus on it. We also assume that the information structure of ‘Keiretsu’ and that of BtoB commerce are different. Each upstream firm’s marginal cost is stochastic and is observable to the downstream firm(s) in ‘Keiretsu’ as long as these they engage in an exclusive relationship, but is the private information of an upstream firm in BtoB commerce. We can show that consumer surplus is higher in ‘Keiretsu’ than in BtoB commerce. Thus, ‘Keiretsu’ does not necessarily have a harmful effect on consumers.

This striking result is due to trade-offs between “information rent” and the “efficiency of the supply channel.” ‘Keiretsu’ can save information rent, but it cannot generally insure an efficient supply channel. On the other hand, auctions promise an efficient supply channel, but downstream firms have to pay information rent to upstream firms thus reducing the production of downstream firms. Note that information rent itself is just a transfer from downstream firms to upstream firms. Taking this into consideration, we show that the advantage of auctions outweighs their disadvantages and the optimal auction outperforms ‘Keiretsu’ from the society’s point of view. However, consumer surplus is smaller in the optimal auction than in ‘Keiretsu’ because information rent reduces production of downstream firms significantly.