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Do Vertical Mergers Facilitate Upstream Collusion? Second Version

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Author Info
Volker Nocke () (Department of Economics, University of Pennsylvania)
Lucy White () (Harvard Business School)

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Abstract

We investigate the impact of vertical mergers on upstream firms' ability to sustain tacit collusion in a repeated game. We identify several effects and show that the net effect of vertical integration is to facilitate collusion. Most importantly, vertical mergers facilitate collusion through the operation of an outlets effect: cheating unintegrated firms can no longer profitably sell to the downstream affiliates of their integrated rivals. However, vertical integration also gives rise to an opposing punishment effect: it is typically more difficult to punish an integrated structure, so that integrated firms are able to make more profits in the punishment phase than unintegrated upstream firms. When downstream firms can condition their prices or quantities on upstream firms' contract offers, two additional effects arise, both of which further facilitate upstream collusion. First, an unintegrated upstream firm's deviation profits are reduced by the reaction effect which arises since the downstream unit of the integrated firm will now react aggressively to upstream deviations. Second, an integrated firm's deviation profit is reduced by the lack-of-commitment effect as it cannot commit to its own downstream price when deviating upstream.

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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 05-013.

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Length: 45 pages
Date of creation: 03 Nov 2003
Date of revision: 08 Mar 2005
Handle: RePEc:pen:papers:05-013

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Related research
Keywords: vertical merger collusion vertical restraint vertical integration repeated game penal code

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Find related papers by JEL classification:
L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
L42 - Industrial Organization - - Antitrust Issues and Policies - - - Vertical Restraints; Resale Price Maintenance; Quantity Discounts
D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection

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  1. Chen, Yongmin, 2001. "On Vertical Mergers and Their Competitive Effects," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 667-85, Winter.
    Other versions:
  2. Volker Nocke & Lucy White, 2003. "Do Vertical Mergers Facilitate Upstream Collusion?," PIER Working Paper Archive 03-033, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
    Other versions:
  3. Hart, O. & Tirole, J., 1990. "Vertical Integration And Market Foreclosure," Working papers 548, Massachusetts Institute of Technology (MIT), Department of Economics.
    Other versions:
  4. McAfee, R Preston & Schwartz, Marius, 1994. "Opportunism in Multilateral Vertical Contracting: Nondiscrimination, Exclusivity, and Uniformity," American Economic Review, American Economic Association, vol. 84(1), pages 210-30, March. [Downloadable!] (restricted)
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  12. Patrick Rey & Thibaud Vergé, 2004. "Bilateral Control with Vertical Contracts," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 728-746, Winter.
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  13. Yongmin Chen, 2005. "Vertical Disintegration," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 14(1), pages 209-229, 03. [Downloadable!] (restricted)
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    Other versions:
    • Aumann, Robert J. & Heifetz, Aviad, 2001. "Incomplete Information," Working Papers 1124, California Institute of Technology, Division of the Humanities and Social Sciences. [Downloadable!]
  15. Levenstein, Margaret C, 1997. "Price Wars and the Stability of Collusion: A Study of the Pre-World War I Bromine Industry," Journal of Industrial Economics, Blackwell Publishing, vol. 45(2), pages 117-37, June. [Downloadable!] (restricted)
  16. George J. Mailath & Volker Nocke & Lucy White, 2004. "When the Punishment Must Fit the Crime: Remarks on the Failure of Simple Penal Codes in Extensive-Form Games," PIER Working Paper Archive 04-039, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
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  17. Woodruff, Christopher, 2002. "Non-contractible investments and vertical integration in the Mexican footwear industry," International Journal of Industrial Organization, Elsevier, vol. 20(8), pages 1197-1224, October. [Downloadable!] (restricted)
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  20. Compte, Olivier & Jenny, Frederic & Rey, Patrick, 2002. "Capacity constraints, mergers and collusion," European Economic Review, Elsevier, vol. 46(1), pages 1-29, January. [Downloadable!] (restricted)
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  24. Ken Hendricks & Robert Porter & Guofu Tan, 2003. "Bidding Rings and the Winner's Curse: The Case of Federal Offshore Oil and Gas Lease Auctions," NBER Working Papers 9836, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  26. Robert H. Porter, 1983. "A Study of Cartel Stability: The Joint Executive Committee, 1880-1886," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 301-314, Autumn. [Downloadable!] (restricted)
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