Vertical Contracting When Competition for Orders Precedes Procurement

Abstract

This paper reverses the standard order between input supply negotiations and downstream competition and assumes that competition for orders takes place prior to procurement of inputs in a vertical chain. In an environment where procurement negotiations involve no private information and no restrictions on the form of pricing, it is found that oligopolistically competitive outcomes will result despite the presence of an upstream monopolist. It is demonstrated that vertical integration is a means by which the monopolist can leverage its market power downstream to the detriment of consumers. However, it does so, not by foreclosing on independent downstream firms, but by softening the competitive behaviour of its own integrated units. Thus, the paper provides a simple rationale for anti-competitive vertical integration in an environment that respects the usual Chicago school assumptions.

Keywords: vertical contracting, vertical integration, monopolisation, bargaining, competition

JEL Classification: L42