Successive Oligopolies, Vertical Downstream Integration and Foreclosure

Vertically integrated firms have repeatedly been accused of abusing a dominant position by refusing to sell the intermediate product to non-integrated downstream producers and thus to practice foreclosure. To evaluate the merit of such an accusation requires an adequate theory of vertical integration which allows to decide whether a refusal to sell follows straightforwardly from profit maximization or is driven by an intent to monopolize. We investigate whether in the case of successive oligopolies vertical integration is profitable for the participating firms and to what extent cross deliveries between integrated and non-integrated firms can be expected to arise. By contrast to the previous literature where at the downstream level Cournot competition has been assumed to prevail between integrated firms and non-integrated downstream producers, we propose a model where integrated firms and non-integrated upstream suppliers meet in Cournot competition and take as given the inverse demand function for both the final and the intermediate product. Game theory is invoked to examine whether an integrated firm will participate in the intermediate market. If marginal costs at the downstream level are constant and identical as between integrated and non-integrated firms, integrated firms will never wish to sell to non-integrated downstream producers they can, however, be expected to buy from non-integrated upstream suppliers. Utilizing theoretical implications regarding pass through of changes in marginal costs we find empirical evidence supporting the applicability of our model to the gasoline industry in Germany. We finally examine to what extent issues of competition policy and public regulation arise. Copyright Springer Science + Business Media, Inc. 2005