Vertical Integration in the Presence of Upstream Competition
Melbourne Business School Working Paper No. 2002-12
53 Pages Posted: 20 Dec 2002 Last revised: 18 Nov 2012
Date Written: November 1, 2004
We analyse vertical integration when there is upstream competition and compare outcomes to the case where upstream assets are owned by a single agent (i.e., upstream monopoly). In so doing, we make two contributions to the modelling of strategic vertical integration. First, we base industry structure - namely, the ownership of assets - firmly within the property rights approach to firm boundaries. Second, we model the potential multilateral negotiations using a fully specified non-cooperative bargaining model designed to easily compare outcomes achieved under upstream competition and monopoly. Given this, we demonstrate that vertical integration can alter the joint payoffs of integrating parties in ex post bargaining; however, this bargaining effect is stronger for firms integrating under upstream competition than upstream monopoly. We also consider the potential for integration to internalise competitive externalities in manner that cannot be achieved under non-integration. We demonstrate that ex post monopolization is more likely to occur when there is an upstream monopoly than when there is upstream competition. Our general conclusion is that the simple intuition that the presence of upstream competition can mitigate and reduce the incentives for socially undesirable vertical integration is misplaced and, depending upon the strength of downstream competition (i.e., product differentiation), the opposite could easily be the case.
Keywords: vertical integration, foreclosure, monopolization, bargaining, competition
JEL Classification: L42
Suggested Citation: Suggested Citation