Double marginalization is a vertical externality that occurs when two firms with market power (i.e., not in a situation of perfect competition), at different vertical levels in the same supply chain, apply a mark-up to their prices.
[1] This is caused by the prospect of facing a steep demand curve slope, prompting the firm to mark-up the price beyond its marginal costs.
[2] Double marginalization is clearly negative from a welfare point of view, as the double markup induces a deadweight loss, because the retail price is higher than the optimal monopoly price a vertically integrated company would set, leading to underproduction.
[3] Thus all social groups are negatively affected because the overall profit for the company is lower, the consumer has to pay more and a smaller amount of units are consumed.
Not only is the total profit lower than in the integrated scenario, but the price is higher, thus reducing the consumer surplus.
There are numerous mechanisms to prevent or at least limit double marginalization.
Note that the above mechanisms only solve the problem of double marginalization; from an overall welfare point of view, the problem of monopoly pricing remains.
It should also be noted that while some of the solutions presented above, such as mergers, have a positive effect in minimizing the double markup present within the vertical competition, but it damages the horizontal competition.