Double marginalization is defined as the “exercise of market power at successive vertical layers in a supply chain.” Dating back to Lerner (1934) the problem that arises as a result of double marginalization is tied to an impetus to mark up the product’s price above marginal cost. According to a 2005 Caltech paper (Vertical Integration of Successive Monopolists: A Classroom Experiment) the sequence of mark-ups “leads to a higher retail price and lower combined profit for the supply chain than would arise if the firms were vertically integrated.”
In short, double marginalization drives the paradoxical outcome of higher buyer prices with lower seller profits. However the paper’s suggestion that vertically integrated supply chains represent a sound response to the double marginalization issue is highly questionable.
This is due to the fact that vertically integrated supply chains are often inflexible in terms of responding to the diverse stakeholder dynamics that are reshaping the ways in which organizations buy and sell in the emerging global economy.
Li, T.; Sethi, S. P. & He, X. Dynamic pricing, production, and channel coordination with stochastic learning Production and Operations Management, Wiley Online Library, 2015, 24, 857-882