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Vertical Networks, Integration, and Connectivity

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  • Dogan, Pinar

Abstract

This paper studies competition in a network industry with a stylized two layered network structure, and examines: (i) price and connectivity incentives of the upstream networks, and (ii) incentives for vertical integration between an upstream network provider and a downstream firm. The main result of this paper is that vertical integration occurs only if the initial installed-base difference between the upstream networks is sufficiently small, and in that case, industry is configured with two vertically integrated networks, which yields highest incentives to invest in quality of interconnection. When the installed-base difference is sufficiently large, there is no integration in the industry, and neither of the firms have an incentive to invest in quality of interconnection. An industry configuration in which only the large network integrates and excludes (or raises cost of) its downstream rival does not appear as an equilibrium outcome: in the presence of a large asymmetry between the networks, when quality of interconnection is a strategic variable, the large network can exercise a substantial market power without vertical integration. Therefore, a vertically separated industry structure does not necessarily yield procompetitive outcomes.

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Paper provided by Harvard Kennedy School of Government in its series Scholarly Articles with number 4863169.

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Date of creation: 2009
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Publication status: Published in Journal of Economics & Management Strategy
Handle: RePEc:hrv:hksfac:4863169

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  1. Hart, O. & Tirole, J., 1990. "Vertical Integration And Market Foreclosure," Working papers 548, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Rey, Patrick & Tirole, Jean, 2007. "A Primer on Foreclosure," Handbook of Industrial Organization, Elsevier.
  3. Farrell, Joseph, 1989. "Converters, Compatibility, and the Control of Interfaces," Department of Economics, Working Paper Series qt8161p50b, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
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  8. Economides, Nicholas & Salop, Steven C, 1992. "Competition and Integration among Complements, and Network Market Structure," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 105-23, March.
  9. Church, Jeffrey & Gandal, Neil, 2004. "Platform Competition in Telecommunications," CEPR Discussion Papers 4659, C.E.P.R. Discussion Papers.
  10. Church, J. & Gandal, N., 1996. "Systems Competition, Vertical Merger and Foreclosure," Papers 6-96, Tel Aviv - the Sackler Institute of Economic Studies.
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  16. Beard, T Randolph & Kaserman, David L & Mayo, John W, 2001. "Regulation, Vertical Integration and Sabotage," Journal of Industrial Economics, Wiley Blackwell, vol. 49(3), pages 319-33, September.
  17. Ordover, Janusz A & Saloner, Garth & Salop, Steven C, 1990. "Equilibrium Vertical Foreclosure," American Economic Review, American Economic Association, vol. 80(1), pages 127-42, March.
  18. Mathewson, G Frank & Winter, Ralph A, 1987. "The Competitive Effects of Vertical Agreements: Comment," American Economic Review, American Economic Association, vol. 77(5), pages 1057-62, December.
  19. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
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Cited by:
  1. Corrado Benassi & Marcella Scrimitore, 2013. "Income Distribution in Network Markets," Working Paper Series 13_13, The Rimini Centre for Economic Analysis.

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