Simulating Vertical Mergers and the Vertical GUPPI Approach

Abstract

Moresi and Salop (2013) have extended the “upward pricing pressure” approach used in analyzing horizontal mergers to the analysis of vertical mergers. They present test expressions called the vGUPPIu and vGUPPId to see if the upstream and downstream prices will rise as a result of the merger. This approach has gained acceptance.

In this paper we present the results of Monte Carlo simulations of a vertical merger for a simple setup with one upstream monopolist and two downstream firms. In the simulations, the upstream price paid by the remaining downstream rival can either rise or fall. The downstream price always falls. The downstream rival may exit even when the upstream price falls.

Based on these simulations, we see if the Moresi and Salop formulas predict the directions of price changes correctly. We also derive a variation on the Moresi and Salop formulation, arriving at different vGUPPI formulas. Overall, neither approach does well. Both versions of the vGUPPIu predict upstream price increases, whereas the simulations show many decreases. The merged firm’s downstream price always falls in the simulations. The Moresi and Salop downstream price test is correct 82.1% of the time, whereas the variant is correct 100% of the time.

Keywords: Vertical Mergers, UPPI, vGUPPI, Industrial Organization, Monte Carlo Simulations, Microeconomics

JEL Classification: L13, L40, L42, D21, D43, C63