In this paper, we show that producers employ exclusive territories when competition exists among distribution channels and discuss the welfare effects of exclusive territories. When the transportation cost is low enough, an increase in the number of distributors can enhance competition and thus lower the retail price. On the other hand, when the transportation cost is high, an increase in the number of distributors raises the retail price and lowers the consumer surplus. In this case, exclusive territories can eliminate the redundant transportation and enhance the profit of whole distribution channel. We develop a three stage game that distributors can choose the exclusive territories or the open market regime. We also establish that each producers employs the exclusive territories in equilibrium. Moreover, we show that such exclusive territories can be Pareto improving.
