Vertical Integration, Foreclosure, and profits in the Presence of Double Marginalization

Whether vertical integration between a downstream oligopolist and an upstream oligopolist is profitable for an integrated pair of firms is shown to depend on whether one means by this that profits increase no matter what other firms do, that all integrated firms are better off when all firms are integrated than when none are, or simply that no downstream-upstream pair of firms has an incentive to deviate from a situation where all firms are integrated. It is also shown to depend on the number of firms in each oligopoly and on the type of interaction that is assumed between firms that are integrated and firms that are not. In particular, it is shown that if no restriction is put on trade between integrated and nonintegrated firms, integrated firms may continue to purchase inputs from the nonintegrated upstream firms, with the goal of raising their downstream rivals' costs. Furthermore, even though firms are identical, asymmetric equilibria, where integrated and nonintegrated firms coexist, may actually arise as an outcome of the integration game.     

Downstream Competition, Foreclosure, and Vertical Integration

This paper analyzes the effect of competition among downstream firms on an upstream firm's payoff and on its incentive to integrate vertically when firms in both segments negotiate optimal contracts. We argue that as downstream competition becomes more intense, the upstream firm obtains a larger share of a smaller downstream industry profit. The upstream firm may encourage downstream competition (even excessively) in response to high downstream bargaining power. The option of vertical integration may be a barrier to entry downstream and may trigger strategic horizontal spinoffs or mergers. We extend the analysis to upstream competition.     

Vertical Integration and Proprietary Information Transfers

Suppose that rival downstream producers of a final good contract with the same upstream supplier of an input and, in the process, reveal private information. A vertical merger between the upstream supplier and one of the downstream firms may dissipate the information advantage of the remaining downstream firms. The welfare consequences of such a merger and related information sharing depend on the value of information, the benefits of integration apart from information sharing, and the nature of upstream competition. In this paper, conditions are found under which owners of a vertically integrated firm are better off breaking up into independent firms. This result may explain AT&T's recent spinoff of Lucent Technologies. Further results suggest that a prohibition on information transfers, such as that often proposed by the Federal Trade Commission and Department of Justice as a precursor to approving vertical mergers, may actually reduce expected consumer surplus and expected social welfare.     

Vertical integration and disruptive cross‐market R&D

We study how vertical market structure affects the incentives of suppliers and customers to develop a new input that will enable the innovator to replace the incumbent supplier. In a vertical setting with an incumbent monopoly upstream supplier and two downstream firms, we show that vertical integration reduces the R&D incentives of the integrated parties, but increases that of the nonintegrated downstream rival. Strategic vertical integration may occur whereby the upstream incumbent integrates with a downstream firm to discourage or even preempt downstream disruptive R&D. Depending on the R&D costs, vertical integration may lower the social rate of innovation.     

Product Differentiation and Upstream-Downstream Relations

This paper examines the relationship between a differentiated downstream market and a specialized upstream market. We analyze three different types of vertical relation between the upstream and downstream sectors when the upstream market supplies specialized and complementary inputs to a downstream product-differentiated market. The first is the benchmark case of decentralized markets, the second is a network of alliances among upstream suppliers, and the third is partial vertical integration. We identify the perfect equilibrium for a symmetric model in each case and show that there is no simple relationship between the degree of connection between upstream and downstream firms and profitability. The key factor affecting prices and the relative profitability of the different market organizations is the degree of product differentiation among the downstream firms, because it affects the intensity of competition among upstream suppliers. We show that vertical foreclosure is not an equilibrium strategy.     

Foreclosure with Incomplete Information

We investigate the robustness of the new foreclosure doctrine and its associated welfare implications to the introduction of incomplete information. In particular, we let the upstream firm's marginal cost be private information, unknown to the downstream firms. The previous literature has argued that vertical integration is harmful because it allows an upstream monopolist to limit output to monopoly levels, whereas a disintegrated structure will "over-sell," producing more in equilibrium. By contrast, we find that with incomplete information, high-cost firms will often "under-sell" in equilibrium, that is, supply less than their monopoly output. Low-cost firms continue to over-sell, so all types of firms have a reason to integrate downstream, but this is socially harmful only for low-cost types. For high-cost firms vertical integration can be Pareto-improving, resulting in higher output, profits, and consumer surplus.     

Who is more aggressive under vertical product differentiation?

In this paper, we introduce quality differences in vertical market and compare the managerial delegation contracts of downstream firms. We find that the owner of a downstream firm that produces low-quality products induces the manager to behave more aggressively when the marginal cost coefficient is low. While when marginal cost coefficient is high, the owner of a downstream firm that produces high-quality products induces the manager to behave more aggressively. It is further found that managerial delegation can improve the profits of downstream firms but reduce the consumer surplus and social welfare.     

Explaining Downstream Integration

We examine the downstream integration decision by businesses, deriving hypotheses from the transaction cost literature which are empirically tested for a sample of 1392 businesses operating in a wide spectrum of industries. Our results provide corroboration for each dimension of the transaction cost framework in explaining why firms might integrate their downstream business activities. Given the large cross-sectional sample, our results provide some evidence of the general validity of the transaction cost framework within the context of downstream integration.     

Vertical Foreclosure, Technological Choice, and Entry on the Intermediate Market

This paper analyzes the profitability of vertical integration for an upstream monopoly facing a potential competitor. We show that it depends on the technology used by the firm when it integrates. We distinguish two types of technologies: standard technologies, used by nonintegrated firms, and nonstandard technologies, reserved for integrated firms and implying the complete foreclosure of nonintegrated firms. Vertical integration with the adoption of a nonstandard technology dominates vertical integration with the adoption of a standard technology and is profitable, as long as the degree of competition in the downstream industry is sufficiently low.     

Vertical Foreclosure, Technological Choice, and Entry on the Intermediate Market

This paper analyzes the profitability of vertical integration for an upstream monopoly facing a potential competitor. We show that it depends on the technology used by the firm when it integrates. We distinguish two types of technologies: standard technologies, used by nonintegrated firms, and nonstandard technologies, reserved for integrated firms and implying the complete foreclosure of nonintegrated firms. Vertical integration with the adoption of a nonstandard technology dominates vertical integration with the adoption of a standard technology and is profitable, as long as the degree of competition in the downstream industry is sufficiently low.     

Arcs of carbon awareness in the value chain and their antecedents

This study examines the patterns and antecedents of firms' value chain greenhouse gas emissions (VCGGE) awareness. Drawing on a sample of 1,322 firms from multiple countries and industries, we use cluster analysis to first evaluate how well firms' VCGGE awareness patterns match traditional value chain integration patterns, identified by prior literature. We then examine how well internal indicators of greenhouse gas emissions (GGE) management predict advanced VCGGE awareness. Our study indicates that VCGGE patterns partially match traditional value chain integration patterns and that firms' VCGGE awareness is much higher for their upstream than downstream activities. Moreover, our findings show that the internal adoption of GGE management is a significant predictor of advanced awareness of VCGGE. Overall, we find that most firms have limited awareness about the magnitude of their VCGGE, suggesting that many opportunities to reduce these emissions, especially in the downstream value chain, remain unexplored.     

Backward Integration by a Dominant Firm

This paper studies the welfare consequences of a vertical merger that raises rivals' costs when downstream competition is a la Cournot between firms with constant asymmetric marginal costs. The main result is that such a vertical merger can nevertheless improve welfare if it involves a downstream firm whose cost is low enough. This is because by raising the input price paid by the nonmerging firms the merger shifts production away from those relatively inefficient producers in favor of the more efficient firm. Yet, there is a trade-off between the gain in productive efficiency and the loss in consumers' surplus caused by the higher downstream price that follows a higher input price. It is also shown, through an example, that this result extends to price competition with differentiated products.     

Vertical merger: monopolization for downstream quasi‐rents

This paper provides a welfare analysis of vertical merger between an input monopolist and downstream firms that compete perfectly in a homogeneous product market. The distinguishing feature of the present model is that the downstream firms face capacity constraints. As a result of downstream quasi‐rents, vertical merger—the extent of merger is gauged by the capacity share of the acquired downstream firm—may either raise or lower final output. An analytical criterion for distinguishing pro‐ and anti‐competitive mergers is derived, which relies entirely on pre‐merger market quantities and the capacity share of the downstream target. A common result is that vertical merger is output‐increasing even when unaffiliated downstream rivals are completely foreclosed. Copyright © 2008 John Wiley & Sons, Ltd.     

Downstream Competition, Bargaining, and Welfare

I analyze the effects of downstream competition when there is bargaining between downstream firms and upstream agents (firms or unions). When bargaining is over a uniform input price, a decrease in the intensity of competition (or a merger) between downstream firms may raise consumer surplus and overall welfare. When bargaining is over a two-part tariff, a decrease in the intensity of competition reduces downstream profits and upstream utility and raises consumer surplus and overall welfare. Standard welfare results of oligopoly theory can be reversed: less competition can be unprofitable for firms and/or beneficial for consumers and society as a whole.     

Product choice with economies of scope

This paper develops a model in which two competing firms on a bounded line each sell two products. Production costs for each firm are lower the closer are its two products. It is shown that there may be anywhere from zero to three possible equilibrium configurations. Equilibrium may entail market segmentation, market interlacing or an intermediate case. The paper contributes to two bodies of literature: (i) Industrial organization. When the line is interpreted as a one-dimensional characteristic space, the model provides an appealing explanation of economies of scope in multi-product firms. (ii) Firm location theory. The model relaxes the unrealistic assumption made in spatial models that each firm has a single outlet and obtains significantly different results.     

The Role of Upstream‐Downstream Competition on Bundling Decisions: Should Regulators Force Firms to Unbundle?

We develop an upstream–downstream model to analyze downstream firms' incentives to bundle. In our framework, the upstream firms are content providers (such as television stations) and the downstream firms are system operators (such as cable/satellite operators). We show that an a la carte regulation (i.e., a regulation that forces downstream firms to unbundle) leads to higher consumer surplus, if the unregulated equilibrium exhibits pure bundling (PB). Hence, our model predicts that in the television industry, which is mainly characterized by PB, an a la carte regulation will be beneficial for the consumers. If, on the other hand, the unregulated equilibrium is characterized by mixed bundling, then an a la carte regulation will increase consumer welfare provided that demand for multiple purchases is strong.     

The pace of intermediate‐product introductions

This paper models frequency of introductions of newer generations of an intermediate‐product sold by an upstream ‘developer’ firm to downstream manufacturer firms. The manufacturers use the intermediate product to manufacture final products, and are heterogeneous in the time it takes them to develop and introduce final products based on the latest generation of the intermediate product. This downstream heterogeneity could arise, for example, from heterogeneity in manufacturers' technical skills or existing patent regimes. Among other results, we show that the optimal frequency of introduction of the intermediate‐product can increase or decrease in the extent of this downstream heterogeneity. Copyright © 2006 John Wiley & Sons, Ltd.     

The organization and relative productivity of Japanese and American industry

This paper compares the structure and productivity of Japanese and American firms. We construct a simple model of labor shares in which the ratio of labor payments to sales is the product of labor's share in take added and the degree of integration. According to Japanese and United States census data, labor shares in value added are fairly similar for Japanese and American firms, whereas the average degree of integration, and therefore the average ratio of payroll to sales of Japanese firms, is distinctly lower than that of their American counterparts, particularly in the machinery and equipment industries. From survey data on Japanese firms in California, we observed payroll-sales ratios that generally lie between values reported for Japan and the United Slates for the machinery and equipment industries. Assuming that Japanese firms in California employ the same technology as their US counterparts, we conclude that the average degree of integration of Japanese firms in California is at least 10% lower. As a result, even though the gross labor productivity of typical Japanese firms in the United States generally, and California in particular, is slightly higher, the former may well be less productive than the latter in terms of net lalmr productivity, measured by value added. While further corroboration is needed, it appears that differences in the extent of integration are an important factor that accounts for reported productivity difference between the two countries.     

下游市场存在竞争的企业集团转移定价研究

基于企业集团面临下游竞争，研究了企业集团的中间产品的转移定价问题。研究结果表明，集团的中间产品的转移价格大干中间产品的边际成本。与Hirshkifer提出的边际成本转移定价策略相比，本文提出的转移定价策略为优。     

Profit‐raising Entry in Vertically Related Markets

We extend the standard vertical oligopoly model to allow for free entry in the upstream sector, and research and development with knowledge spillover in the downstream sector. The fact that an increase in the number of firms lowers industry profit is the common wisdom that may not hold in vertical structure of production. We provide a complementary reasoning and find that aggregate downstream profit can increase with downstream entry when the knowledge spillover effect and the entry cost are moderate. Copyright © 2014 John Wiley & Sons, Ltd.