To be able to implement a vertical price squeeze, a firm must be vertically integrated, and control an essential wholesale input to the retail service. A firm implementing a price squeeze offers to supply this essential input to its retail competitors only at a price greatly in excess of its costs.
The key elements of a price squeeze are:
- The firm demands a price for the essential facility that is so high that it is not possible for an equally-efficient retail-stage competitor to operate profitably (or even survive) given the level of retail prices, and
- The firm does not charge its own downstream operation this high price.
In the extreme, the firm might demand a price for the essential input that is higher than the full retail price of the service.
A vertical price squeeze can only succeed if the essential input has no effective substitutes. If such substitutes are available, the price squeeze will simply encourage entrants to use the substitute to produce competing retail services.
A price squeeze has a similar effect to a refusal to supply an essential facility. By charging a high price for the essential input, a vertically integrated firm can reduce the effectiveness of its competitors, or in the extreme force them out of the market (see Figure 1).
Figure 1: Example of a Vertical Price Squeeze
In the figure, an incumbent firm owns an essential input, on which an entrant depends in order to provide service to its customers. Both firms have the same costs at the retail stage of the market. The incumbent obtains the essential input at incremental cost, but charges the entrant a price substantially greater than incremental cost. As a result, the entrant’s total costs exceed the retail price for the service, and it is forced to exit the market.
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Remedies for Refusal to Supply and Price Squeezes