Product differentiation and collusion sustainability when collusion is costly

A widely-debated question in recent years by both strategy theorists and antitrust practitioners is the role that product differentiation between firms has on the ability of firms to sustain a collusive agreement in order to reduce the strength of competition and gain higher profits. This article addresses the following question: what happens to the “product differentiation-collusion sustainability” 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 “product 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 product differentiation degree, the relationship between product differentiation and collusion sustainability is always positive (negative), while if the gains from collusion are inverse U-shape, the relationship is inverse U-shape 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.