Competitive Prices and Organizational Choices

We construct a price-theoretic model of integration decisions and show that these choices may adversely affect consumers, even in the absence of monopoly power in supply and product markets. Integration is costly to implement but is effective at coordinating production decisions. The price of output helps to determine the organizational form chosen: there is an inverted-U relation between the degree of integration and product prices. Moreover, organizational choices affect output: integration is more productive than non-integration at low prices, and less productive at high prices. Since shocks to industries affect product prices, reorganizations are likely to take place in coordinated fashion and be industry specific, consistent with the evidence. Since the price range in which integration maximizes productivity generally differs from the one in which it maximizes managerial welfare, organizational choices will often be second-best inefficient. We show that there are instances in which entry of low-cost suppliers can hurt consumers by changing the terms of trade in the supplier market, thereby inducing reorganizations that raise prices.