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Vertical Networks, Integration, and Connectivity

  • P. Dogan

This paper studies competition in a network industry with a stylized two layered network structure, and examines: (i) price and connectivity incentives of the upstream networks, and (ii) incentives for vertical integration between an upstream network provider and a downstream firm. The main result of this paper is that vertical integration occurs only if the initial installed-base difference between the upstream networks is sufficiently small, and in that case, industry is configured with two vertically integrated networks, which yields highest incentives to invest in quality of interconnection. When the installed-base difference is sufficiently large, there is no integration in the industry, and neither of the firms have an incentive to invest in quality of interconnection. An industry configuration in which only the large network integrates and excludes (or raises cost of) its downstream rival does not appear as an equilibrium outcome: in the presence of a large asymmetry between the networks, when quality of interconnection is a strategic variable, the large network can exercise a substantial market power without vertical integration. Therefore, a vertically separated industry structure does not necessarily yield procompetitive outcomes.

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Paper provided by Harvard University OpenScholar in its series Working Paper with number 33644.

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Handle: RePEc:qsh:wpaper:33644
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  1. Ordover, Janusz A & Saloner, Garth & Salop, Steven C, 1990. "Equilibrium Vertical Foreclosure," American Economic Review, American Economic Association, vol. 80(1), pages 127-42, March.
  2. Mathewson, G Frank & Winter, Ralph A, 1987. "The Competitive Effects of Vertical Agreements: Comment," American Economic Review, American Economic Association, vol. 77(5), pages 1057-62, December.
  3. Tobias Kretschmer, 2004. "Upgrading and niche usage of PC operating systems," LSE Research Online Documents on Economics 802, London School of Economics and Political Science, LSE Library.
  4. Rey, Patrick & Tirole, Jean, 2003. "A Primer on Foreclosure," IDEI Working Papers 203, Institut d'Économie Industrielle (IDEI), Toulouse, revised Nov 2005.
  5. David A. Malueg & Marius Schwartz, 2006. "COMPATIBILITY INCENTIVES OF A LARGE NETWORK FACING MULTIPLE RIVALS -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 54(4), pages 527-567, December.
  6. Beard, T Randolph & Kaserman, David L & Mayo, John W, 2001. "Regulation, Vertical Integration and Sabotage," Journal of Industrial Economics, Wiley Blackwell, vol. 49(3), pages 319-33, September.
  7. Farrell, Joseph & Saloner, Garth, 1992. "Converters, Compatibility, and the Control of Interfaces," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 9-35, March.
  8. John C. Harsanyi & Reinhard Selten, 1988. "A General Theory of Equilibrium Selection in Games," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582384, June.
  9. Hart, O. & Tirole, J., 1990. "Vertical Integration And Market Foreclosure," Working papers 548, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Foros, Oystein & Hansen, Bjorn, 2001. "Competition and compatibility among Internet Service Providers," Information Economics and Policy, Elsevier, vol. 13(4), pages 411-425, December.
  11. Joseph Farrell & Paul Klemperer, 2006. "Co-ordination and Lock-in: Competition with Switching Costs and Network Effects," Economics Papers 2006-W07, Economics Group, Nuffield College, University of Oxford.
  12. Church, Jeffrey & Gandal, Neil, 2004. "Platform Competition in Telecommunications," CEPR Discussion Papers 4659, C.E.P.R. Discussion Papers.
  13. Church, J. & Gandal, N., 1996. "Systems Competition, Vertical Merger and Foreclosure," Papers 6-96, Tel Aviv - the Sackler Institute of Economic Studies.
  14. Nicholas Economides, 1995. "The Economics of Networks," Working Papers 94-24, New York University, Leonard N. Stern School of Business, Department of Economics, revised Sep 1995.
  15. Joseph Farrell & Garth Saloner, 1985. "Installed Base and Compatibility With Implications for Product Preannouncements," Working papers 385, Massachusetts Institute of Technology (MIT), Department of Economics.
  16. Cremer, Jacques & Rey, Patrick & Tirole, Jean, 2000. "Connectivity in the Commercial Internet," Journal of Industrial Economics, Wiley Blackwell, vol. 48(4), pages 433-72, December.
  17. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
  18. Riordan, M.H., 1996. "Anticompetitive Vertical Integration by a Dominant Firm," Papers 64, Boston University - Industry Studies Programme.
  19. Economides, Nicholas & White, Lawrence J., 1994. "Networks and compatibility: Implications for antitrust," European Economic Review, Elsevier, vol. 38(3-4), pages 651-662, April.
  20. Economides, Nicholas & Salop, Steven C, 1992. "Competition and Integration among Complements, and Network Market Structure," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 105-23, March.
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