Vertical Mergers and Competition with a Regulated Bottleneck Monopoly

Abstract

Consider a bottleneck monopoly whose access charge is regulated above marginal cost and provides access to an oligopoly of downstream firms. Should the monopolist be allowed to vertically integrate into the downstream market? For the general run of oligopolistic market structures, we show that a vertical merger (or any set of vertical restraints that eliminates the externalities between the upstream and the downstream firm), will not decrease welfare in most cases.

Vertical integration is irrelevant if the downstream market is perfectly competitive. With an oligopoly, the short- and long-run effects are somewhat different. In the short run consumers and the integrated firm always win, but competitors are hurt because they lose oligopolistic rents. Most of the time welfare increases unless output is redistributed away from efficient competitors toward a very inefficient vertically integrated firm. Finally, if there is free entry, competitors and consumers are indifferent in the long-run and vertical integration always increases welfare.

Keywords: access charge, essential input, free entry, network industries, oligopoly, stablity conditions

JEL Classification: L12, L22, L51