Can Vertical Integration by a Monopsonist Harm Consumer Welfare?

Abstract

Vertical integration by a monopsonist is generally believed not to harm consumers. This paper demonstrates, in a natural economic setting, that this conventional wisdom may not hold. We model bargaining between a monopsonist and independent suppliers when it is difficult to write binding long-term supply price contracts. Thus, a vertically separated monopolist is vulnerable to hold-up. Without integration, we demonstrate that a bottleneck monopsonist has an incentive to encourage more firms in a related segment than would arise in a pure neoclassical monopoly. Having more firms mitigates the hold-up power of any one. This, however, distorts the cost structure of the industry toward greater industry output and, hence, lowers final good prices. Vertical integration mitigates the hold-up problem faced by the monopsonist. It allows it to generate and appropriate a greater level of industry profits; largely at the expense of consumers. It is shown that horizontal competition reduces the anti-competitive incentives and harm from integration.

JEL Classification: L42