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Vertical Integration in the Presence of Upstream Competition

Author

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  • Catherine C. de Fontenay
  • Joshua S. Gans

Abstract

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

Suggested Citation

  • Catherine C. de Fontenay & Joshua S. Gans, 2004. "Vertical Integration in the Presence of Upstream Competition," Department of Economics - Working Papers Series 904, The University of Melbourne.
  • Handle: RePEc:mlb:wpaper:904
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    File URL: http://www.economics.unimelb.edu.au/downloads/wpapers-04/904.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    vertical integration; foreclosure; monopolization; bargaining; competition.;

    JEL classification:

    • L42 - Industrial Organization - - Antitrust Issues and Policies - - - Vertical Restraints; Resale Price Maintenance; Quantity Discounts

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