Effects of vertical integration on price and volume: An empirical inquiry

A simple model with two stages of production is used for deriving some empirically testable hypotheses. Firms (two upstream and two downstream) in the industry are either vertically integrated or not, hence the industry has three alternative patterns: Complete unintegrated, partially integrated, or fully integrated.Final good prices, outputs and profits of firms are different in each integration pattern but what is optimal can not be stated (i.e., pay-offs are much too complicated in order to solve the sub-game equilibrium).The essential feature of the model is that there are external markets for the intermediate inputs. Hence input trade between the four firms/divisions need not balance since excess supply or demand is traded at the external market. With this feature purely downstream exogenous shocks have no effect on upstream pricing nor production decisions if all four firms are unintegrated. Such exogenous shocks have non-zero effects if at least one firm is vertically integrated. There are also other dissimilarities in comparative statics of each industry integration pattern.An indirect method to test the effects of vertical integration on price and volume is presented and empirically tested. Depending on the vertical integration pattern of an industry exogenous shocks have dissimilar effects on prices and outputs of the final and intermediate good. A four equations system is estimated by using Finnish forest industry firm data. Final good demand rise has a reducing effect on both paper and pulp prices. Stumpage prices (upstream marginal costs) have a negative impact on paper and pulp production and a positive impact on prices. These effects from upstream (downstream) stage into downstream (upstream) market should not occur when all firms are unintegrated.This is a revised version of a paper which was presented at seminars at Brussels, Turku, Vienna, and Stuttgart. I would like to thank seminar participants (specially Frank Schmid) and anonymous referees for helpful comments. Financial support from the Marcus Wallenberg Foundation is gratefully acknowledged.     

Bargaining power and firm profits in asymmetric duopoly: an inverted-U relationship

This paper investigates the effects of bargaining power on downstream firms’ profits. Consider a vertically related industry consisting of one upstream and two downstream firms, the latter having different marginal costs. Each pair bargains over a linear wholesale price, and then the downstream firms engage in Cournot competition. We show that the inefficient downstream firm may benefit from an increase in the bargaining power of the upstream firm. Furthermore, we obtain similar results when each downstream firm trades with its exclusive upstream agent, under non-linear demand function, or when downstream firms compete in price.     

R&D subsidies in a duopoly market with outsourcing to the rival firm

This paper investigates the effects of a public uniform R&D subsidy policy in a downstream duopoly market in which a nonintegrated firm, which faces a lower marginal cost, outsources inputs from its vertically integrated rival. The findings show that, in this market structure, such a policy has relevant effects largely differentiated between downstream competitors, as it can significantly modify the relative market shares and profitability of competing firms. Unlike the standard Cournot setting augmented with R&D, results show that the subsidy policy can have different (counterintuitive) effects on R&D investments, output, and profits of the vertically integrated producer and the vertically separated firm, which hold in both cases of exogenous and endogenous (optimal) subsidy. Our findings offer some testable implications and suggest that a subsidy policy in a market with outsourcing to a rival should also consider the different effects of this approach on competitors.     

STRATEGIC OUTSOURCING UNDER ECONOMIES OF SCALE

We show that economies of scale in upstream production can lead both the disintegrated downstream firm as well as its vertically integrated rival to outsource offshore for intermediate goods, even if offshore production has a moderate cost disadvantage compared to in‐house production of the vertically integrated firm.     

Cross-border mergers in vertically related industries

We construct a tractable model of an oligopolistic industry that allows us to capture the role of the vertical structure in the incentives for and implications of cross-border horizontal mergers. We show that vertical integration can increase the gains from cross-border mergers. We also demonstrate how market concentration interacts with costs in the decision of a relatively efficient foreign firm located in one country (source) to merge with a disintegrated or an integrated firm in another country (target) when the industry is vertically related. Absent any merger incentives in an autarkic equilibrium, we demonstrate that vertical integration can raise the incentives for diversification in production and add to the gains from cross-border horizontal mergers. Any additional gain from cross-border horizontal mergers, due to the existence of a vertically integrated production structure, is shown to be sensitive to the relative market concentration across countries. Cross-border mergers will be triggered by a relatively cost-efficient source taking over a disintegrated target when pre-merger competition among the disintegrated firms is relatively intense but, otherwise, the initial target will be a vertically integrated firm.     

Imported inputs and privatization in downstream mixed oligopoly with foreign ownership

This paper examines welfare implications of privatization in a mixed oligopoly with vertically related markets, where an upstream foreign monopolist sells an essential input to public and private firms located downstream in the domestic country. The impact on domestic welfare of privatizing the downstream public firm is shown to contain three effects. The first is an output distortion effect, which negatively affects welfare since privatization decreases the production of final good for consumption. The second is an input price lowering effect resulting from a decrease in derived demand for the input. When the level of privatization increases, a decrease in final good production lowers input demand, causing input price to decline and domestic welfare to increase. The third is a rent‐leaking effect associated with foreign ownership in the downstream private firm. The rival domestic firm strategically increases its final good production, causing profits accrued to foreign investors to increase and domestic welfare to decline. Without foreign ownership in the downstream private firm, the optimal policy toward the public firm is complete privatization as the output distortion effect is dominated by the input price lowering effect. With foreign ownership, however, complete privatization can never be socially optimal due to the additional negative impact on domestic welfare of the rent‐leaking effect. We further discuss implications for domestic welfare under different privatization schemes (e.g., selling the privatization shares to the upstream foreign monopolist or to the rival domestic firm).     

Incentives to invest and to give access to non-regulated new technologies

We analyze the incentives of a vertically integrated firm, which is a regulated monopolist in the wholesale market and competes with an entrant in the retail market, to invest and to give access to a new wholesale technology. The new technology represents a non-drastic innovation that produces retail services of a higher quality than the old technology, and is left unregulated. We show that for intermediate values of the access price for the old technology, the vertically integrated firm may decide not to invest. When investment occurs, the vertically integrated firm may be induced to give access to the entrant for a low access price for the old technology. Furthermore, when both firms can invest, investment occurs under a larger set of circumstances, and it is the entrant the firm that invests in more cases. We also discuss the implications for the regulation of the old technology.     

Make vs buy in a monopoly with demand or cost uncertainty

The issue of technical progress under uncertainty is nested into the debate on vertical integration versus outsourcing, to show that, in general, the former is preferable to the latter in terms of both expected profits and technological efficiency. It is then shown that there exist (i) an optimal two part tariff where the unit price set by the upstream firm is conditional upon its R&D effort, and (ii) an optimal contract specifying the input price in terms of the initial capabilities of the sub-contractor, whereby the industry replicates the same performance as the vertically integrated firm as for both profits and R&D efforts.     

Input Prices as Signals of Costs to a Downstream Rival and Customer

We consider a dual distribution channel in which a vertically integrated manufacturer competes with a downstream rival in a retail market and also sells an input to the rival. We use a signalling model with a continuum of types to examine a situation in which the manufacturer has private information on the production cost of its retail product. We show that in a separating equilibrium under Cournot (Bertrand) retail competition, the manufacturer signals the uncompetitiveness (competitiveness) of its firm by charging a smaller input price than the optimal price under complete information.     

Using Market Structure to Regulate a Vertically Integrated Monopolist

A natural monopolist whose cost is private information produces a good which is combined with another good that can be produced by the monopolist or by other firms. The agency that regulates the monopolist can impose any of several different market structures in the industry: integrated monopoly, vertical separation with free entry downstream, or liberalization downstream (both integrated and independent production). When several firms produce downstream, a Cournot quantity-setting game with free entry determines the market price. We derive the optimal contracts to offer the monopolist under all three market structures and examine the influence of downstream cost differences on access prices.We then study the optimal regulatory policy where the regulator can condition the downstream market structure on the monopolist's cost report to the regulator. The optimal regulatory policy awards a monopoly to a low-cost upstream firm, but requires free entry downstream if the monopolist reports high upstream costs. Thus, the choice of market structure is an additional tool to limit rent extraction by the monopolist. Simulation analysis reveals the possibility of significant welfare gains from this additional regulatory tool.     

声誉、政治关系与企业垂直整合

文章针对我国经济转轨的实际,利用上市公司数据,实证考察了声誉和政治关系对企业垂直整合的影响。研究发现,由于较易与利益相关者订立合约,声誉良好企业垂直整合的程度较低;相反,政治关联企业更有动机和能力通过涉足上下游产业来攫取垄断利润,从而垂直整合的程度较高。基于制度环境的分析显示,声誉和政治关系对企业垂直整合的影响在弱制度环境下更为明显。此外,公司所有权也影响了声誉、政治关系与垂直整合间的关系。声誉良好的民营企业表现出更低的垂直整合度,而有政治关联的国有企业进入上下游产业的动机更强。     

Capital-accumulation games under environmental regulation and duopolistic competition

In a differential game between two symmetric firms, provided with a clean and a dirty production activity, it is analyzed how investment and emissions are affected by environmental regulation. If both firms face the same environmental policy, a stricter policy reduces long-run investment in the dirty activity, while the impact on the clean activity is ambiguous. Both long-run emissions of each firm and total emissions decrease. This result does not necessarily hold if both firms face different policy instruments: Each firm's investment levels increase with a stricter environmental policy towards its rival, which causes more emissions by this firm.     

Vertically Related Markets,Foreign Competition and Optimal Privatization Policy

This paper examines the optimal privatization policy in vertically related markets in which an upstream public firm competes with a foreign private rival in supplying a produced input to the domestic and foreign downstream firms competing in the domestic market. It shows that if the upstream public firm's market share is sufficiently high, full nationalization is optimal and the resulting profit margin is positive. However, complete privatization is never optimal. Numerical simulations reveal both the diverse optimal privatization regimes and the patterns of optimal privatization levels with varying numbers of the domestic and foreign downstream firms.     

The impacts of suppliers and mutual outsourcing on organizational forms

We consider a downstream duopoly model with a monopolistic common supplier and mutual outsourcing between the two symmetric downstream firms. The market structure captures the recent procurement environment in the smartphone industry. We also incorporate managerial delegation into the duopoly model because deciding on organizational forms within a firm is critical to achieving better performance in almost all industries. There is an equilibrium in which only one of the firms delegates its downstream production to its sales manager. A delegating firm becomes less aggressive. The profits when both firms delegate can be higher than those when no firm delegates. Social welfare when both firms delegate can be smaller than that when no firm delegates.     

Firm routines,customer switching and market selection under duopoly

This paper explores the dynamics of market selection for an industry in which firms employ relatively simple pricing, production and investment routines and in which consumers switch between rival firms in response to price differentials but do not all do so instantaneously. The key issue is whether market processes result in the elimination of less efficient firms by their more efficient rivals. That is to say, do such processes unfailingly increase the efficiency with which available economic resources are used? In the context of duopoly, we show that the survival of the more efficient firm is not guaranteed and that, more generally, the outcome depends upon the speeds with which firms adjust prices and capacities and with which customers switch between rival firms.     

Vertically integrated producer when a rival is also a customer: impact of demand uncertainty

When a vertically integrated producer (VIP) is also a supplier of a component for its rival firm, it was found that the profit in a decentralized structure is higher for the VIP than the profit in a centralized structure under deterministic demand. In contrast, we found that firms’ ordering decisions under uncertain demand can reverse this findings and it is more likely to happen as demand variability increases.     

STRATEGIC LOBBYING BY POTENTIAL INDUSTRY ENTRANTS*

A firm which lobbies government for a change in policy, say an import tariff, can increase its profits in two ways. First, the policy can increase the profits of all firms in the industry. This effect therefore involves a free-rider problem. Second, a firm's lobbying expenditures may signal other firms about its costs and interests. For example, a firm with low marginal costs may profit much from an import ban. Other firms which see that this firm expects to profit much from the ban may decide not to enter the industry. This may further increase the low-cost firm's profits.     

Foreign market entry,upstream market power,and endogenous mode of downstream competition

In a differentiated duopoly model of trade and FDI featuring both horizontal and vertical product differentiation, we examine whether globalization and trade policy measures can generate welfare gains by leading firms to change their mode of competition. We show that when a high-quality foreign variety is manufactured under large frictions due to upstream monopoly power, a foreign firm can become a Bertrand competitor against a Cournot local rival in equilibrium, especially when the relative product quality of the foreign variety is sufficiently high and trade costs are sufficiently low (implying higher input price distortions due to double marginalization). Our results suggest that such strategic asymmetry is welfare improving and that the availability of FDI as an alternative to trade can make welfare-enhancing strategic asymmetry even more likely, especially when both input trade costs and fixed investment costs are sufficiently low and trade costs in final goods are sufficiently large.     

OPTIMAL POLICY FOR PRODUCT R&D WITH ENDOGENOUS QUALITY ORDERING: ASYMMETRIC DUOPOLY*

We examine the optimal R&D subsidy/tax policy under a vertically differentiated duopoly. In a significant departure from the existing work, we consider the case of asymmetric costs of product R&D where there is a small technology gap between firms. In our analysis, the endogeneity of quality ordering is explicitly taken into account. We demonstrate the possible anti‐leapfrogging effect of R&D subsidy/tax policy. By committing to a firm‐specific subsidy schedule contingent on firms’ quality choices, the government can not only correct distortions in product quality but also select the socially preferred equilibrium. The latter role is fulfilled by preventing the technologically inferior firm from becoming a quality leader in the industry. Both Bertrand and Cournot cases are analysed.     

A Note on Strategic Trade Policy and Endogenous Quality Choice*

This paper shows that some of the main policy implications in Park (2001 ) and Zhou, Spencer, and Vertinsky (2002 ) are sensitive to their assumptions on marginal production costs. The unilaterally optimal policy for investment towards quality improvement is analyzed, assuming constant and non‐negative marginal production costs under vertically differentiated international duopoly. If marginal production costs are different across firms, the optimal policy for each exporting country may be opposite in its sign from that shown by the existing papers under Bertrand competition. The policy reversal may also occur for the low‐quality exporting country under Cournot competition.