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The economic analysis of product substitutability and intimidation effect on vertical integration

Author

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  • Yu-Chieh Chang

    (Department of Applied Economics, National Chung Hsing University, Taichung, Taiwan)

  • Shu-Yi Liao

    (Department of Applied Economics, National Chung Hsing University, Taichung, Taiwan)

Abstract

This study applied the modified Cournot duopoly model proposed by Buehler and Schmutzler (2008) and Milliou and Pavlou (2013) to analyze and compare the economic efficiency of the separation model and vertical integration model. For the industry of downstream Research and Development (R&D), this model examines the effect of market size and product substitutability on the economic output. We establish the following results: (i) the benefits of a downstream firm on vertical integration will increase when the product substitutability is lower. (ii) While the market size becomes bigger, the benefit is further enhanced this conclusion. The integration firm will promote investment in R&D to cause intimidation effect. (iii) When the product substitutability is higher to a certain degree, the benefits will also increase. Thus, high degree of product homogeneity and high degree of product heterogeneity are more suitable for vertical integration. In the long run, the industry which will extend or increase in demand suggests a merger as early as possible.

Suggested Citation

  • Yu-Chieh Chang & Shu-Yi Liao, 2019. "The economic analysis of product substitutability and intimidation effect on vertical integration," Journal of Administrative and Business Studies, Professor Dr. Usman Raja, vol. 5(4), pages 206-218.
    • Handle: RePEc:apb:jabsss:2019:p:206-218
    DOI: 10.20474/jabs-5.4.2
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    References listed on IDEAS

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    1. Greenhut, M L & Ohta, H, 1979. "Vertical Integration of Successive Oligopolists," American Economic Review, American Economic Association, vol. 69(1), pages 137-141, March.
    2. Stefan Buehler & Armin Schmutzler, 2004. "Intimidating Competitors � Endogenous Vertical Integration and Downstream Investment in Successive Oligopoly," SOI - Working Papers 0409, Socioeconomic Institute - University of Zurich, revised Jul 2005.
    3. Oliver Hart & Jean Tirole, 1990. "Vertical Integration and Market Foreclosure," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1990 Micr), pages 205-286.
    4. Buehler Stefan & Schmutzler Armin, 2005. "Asymmetric Vertical Integration," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 5(1), pages 1-27, January.
    5. Buehler, Stefan & Schmutzler, Armin, 2008. "Intimidating competitors -- Endogenous vertical integration and downstream investment in successive oligopoly," International Journal of Industrial Organization, Elsevier, vol. 26(1), pages 247-265, January.
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