The Incentive for Vertical Integration
AbstractThis paper evaluates the incentive of firms to vertically integrate in a simple 2X2 Bertrand model of two substitutes that are each comprised of two complementary components. It confirms that all prices fall as a result of a vertical merger. Further, we find that, when the composite goods are poor substitutes, producers of complementary components are better off after integration. Thus, at equilibrium, each pair of complementary goods is produced by a single firm (parallel vertical integration). In contrast, when the composite goods are close substitutes, vertical integration reduces profits of the merging firms and is therefore undesirable. Thus, at equilibrium, all four products are produced by independent firms (independent ownership). The reason for the change in the direction of the incentive to merge is that, as the composite goods become closer substitutes, competition between them reduces prices (in comparison to full monopoly) thereby eliminating the usefulness of a vertical merger in accomplishing the same price effect. We also find that, for intermediate levels of substitution, firms producing complementary components prefer to merge only if the substitute good is produced by an integrated firm. Thus, for intermediate levels of substitution, both parallel vertical integration and independent ownership are equilibria. When the demand system is symmetric, total surplus is higher in parallel vertical integration, for all degrees of substitution among the products, even for the case when the goods are close substitutes and parallel vertical integration is not the equilibrium outcome. Thus, the market provides less vertical integration than is optimal from a social surplus maximizing point of view.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by NET Institute in its series Working Papers with number 05-01.
Length: 17 pages
Date of creation: Jan 2005
Date of revision: Jan 2005
Contact details of provider:
Web page: http://www.NETinst.org/
Mergers; vertical integration;
Other versions of this item:
- Nicholas Economides, 1994. "The Incentive for Vertical Integration," Working Papers 94-05, New York University, Leonard N. Stern School of Business, Department of Economics.
- Nicholas Economides, 2005. "The Incentive for Vertical Integration," Working Papers 05-01, New York University, Leonard N. Stern School of Business, Department of Economics.
- L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
- D4 - Microeconomics - - Market Structure and Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-08-26 (All new papers)
- NEP-COM-2006-08-26 (Industrial Competition)
- NEP-IND-2006-08-26 (Industrial Organization)
- NEP-MIC-2006-08-26 (Microeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Comanor, William S & Frech, H E, III, 1985. "The Competitive Effects of Vertical Agreements?," American Economic Review, American Economic Association, vol. 75(3), pages 539-46, June.
- Salinger, Michael A, 1989. "The Meaning of "Upstream" and "Downstream" and the Implications for Modeling Vertical Mergers," Journal of Industrial Economics, Wiley Blackwell, vol. 37(4), pages 373-87, June.
- Salinger, Michael A, 1988. "Vertical Mergers and Market Foreclosure," The Quarterly Journal of Economics, MIT Press, vol. 103(2), pages 345-56, May.
- Nicholas Economides, 2007.
"Nonbanks in the Payments System: Vertical Integration Issues,"
07-06, NET Institute.
- Nicholas Economides, 2007. "Nonbanks in the payments system: vertical integration issues," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Nicholas Economides).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.