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Vertical Integration in the Presence of Upstream Competition

Listed author(s):
  • Catherine C. de Fontenay
  • Joshua S. Gans

We analyze vertical integration in the case of upstream competition and compare outcomes to the case where upstream assets are owned by a single agent (i.e., upstream monopoly). In so doing, we make two contributions to the modelling of strategic vertical integration. First, we base industry structure – namely, the ownership of assets – firmly within the property rights approach to firm boundaries. Second, we model the potential multilateral negotiations using a fully specified, non-cooperative bargaining model designed to easily compare outcomes achieved under upstream competition and monopoly. Given this, we demonstrate that vertical integration can alter the joint payoff of integrating parties in ex post bargaining; however, this bargaining effect is stronger for firms integrating under upstream competition than upstream monopoly. We also consider the potential for integration to internalize competitive externalities in a manner that cannot be achieved under non-integration; i.e., by favouring internal over external supply. We demonstrate that ex post monopolization is more likely to occur when there is an upstream monopoly than when there is upstream competition. Our general conclusion is that the simple intuition that the presence of upstream competition can mitigate and reduce the incentives for socially undesirable vertical integration is misplaced and, depending upon the strength of downstream competition (i.e., product differentiation), the opposite could easily be the case. Journal of Economic Literature Classification Number: L42

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File URL: http://www.economics.unimelb.edu.au/downloads/wpapers-04/904.pdf
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Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 904.

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Length: 60 pages
Date of creation: 2004
Handle: RePEc:mlb:wpaper:904
Contact details of provider: Postal:
Department of Economics, The University of Melbourne, 4th Floor, FBE Building, Level 4, 111 Barry Street. Victoria, 3010, Australia

Phone: +61 3 8344 5355
Fax: +61 3 8344 6899
Web page: http://fbe.unimelb.edu.au/economics
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  1. Philippe Aghion & Jean Tirole, 1994. "The Management of Innovation," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 1185-1209.
  2. Chemla, G., 1999. "Downstream Competition, Foreclosure, and Vertical Integration," Papers 99-18, Paris X - Nanterre, U.F.R. de Sc. Ec. Gest. Maths Infor..
  3. Ilya Segal & Michael D. Whinston, 2003. "Robust Predictions for Bilateral Contracting with Externalities," Econometrica, Econometric Society, vol. 71(3), pages 757-791, 05.
  4. Hart, O. & Tirole, J., 1990. "Vertical Integration And Market Foreclosure," Working papers 548, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Daniel P. O'Brien & Greg Shaffer, 1992. "Vertical Control with Bilateral Contracts," RAND Journal of Economics, The RAND Corporation, vol. 23(3), pages 299-308, Autumn.
  6. Ilya Segal, 1999. "Contracting with Externalities," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 337-388.
  7. Yongmin Chen, 2000. "On Vertical Mergers and Their Competitive Effects," Econometric Society World Congress 2000 Contributed Papers 0383, Econometric Society.
  8. Mathias Dewatripont, 1989. "Renegotiation and Information Revelation Over Time: The Case of Optimal Labor Contracts," The Quarterly Journal of Economics, Oxford University Press, vol. 104(3), pages 589-619.
  9. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Roger B. Myerson, 1978. "Conference Structures and Fair Allocation Rules," Discussion Papers 363, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Patrick Rey & Thibaud Vergé, 2004. "Bilateral Control with Vertical Contracts," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 728-746, Winter.
  12. Inderst, Roman & Wey, Christian, 2003. " Bargaining, Mergers, and Technology Choice in Bilaterally Oligopolistic Industries," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 1-19, Spring.
  13. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
  14. Jonas Björnerstedt & Johan Stennek, 2001. "Bilateral Oligopoly," CIG Working Papers FS IV 01-08, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG).
  15. Matthew O. Jackson & Asher Wolinsky, 1995. "A Strategic Model of Social and Economic Networks," Discussion Papers 1098R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  16. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1119-1158, December.
  17. repec:hhs:iuiwop:555 is not listed on IDEAS
  18. Catherine C. de Fontenay & Joshua S. Gans, 2003. "Organizational Design and Technology Choice under Intrafirm Bargaining: Comment," American Economic Review, American Economic Association, vol. 93(1), pages 448-455, March.
  19. Björnerstedt, Jonas & Stennek, Johan, 2001. "Bilateral Oligopoly," Working Paper Series 555, Research Institute of Industrial Economics.
  20. repec:dau:papers:123456789/6313 is not listed on IDEAS
  21. Aghion, Philippe & Tirole, Jean, 1994. "On the Management of Innovation," IDEI Working Papers 36, Institut d'Économie Industrielle (IDEI), Toulouse.
  22. Lars A. Stole & Jeffrey Zwiebel, 1996. "Intra-firm Bargaining under Non-binding Contracts," Review of Economic Studies, Oxford University Press, vol. 63(3), pages 375-410.
  23. Ordover, Janusz A & Saloner, Garth & Salop, Steven C, 1990. "Equilibrium Vertical Foreclosure," American Economic Review, American Economic Association, vol. 80(1), pages 127-142, March.
  24. Gilles Chemla, 2003. "Downstream Competition, Foreclosure, and Vertical Integration," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 12(2), pages 261-289, 06.
  25. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  26. Rachel E. Kranton & Deborah F. Minehart, 2001. "A Theory of Buyer-Seller Networks," American Economic Review, American Economic Association, vol. 91(3), pages 485-508, June.
  27. 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 210-230, March.
  28. John McLaren, 2000. ""Globalization" and Vertical Structure," American Economic Review, American Economic Association, vol. 90(5), pages 1239-1254, December.
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