Backward integration and collusion in a duopoly model with asymmetric costs

This paper formalizes the idea that input transactions might be used to implement side payments among colluding firms. A model is proposed to analyze the effect of backward integration on collusive outcomes in a downstream duopoly with asymmetric marginal costs. Vertical integration expands the set of collusive outcomes that are sustainable for a given realization of the discount factor. This is an additional effect of vertical integration that antitrust authorities should consider. Side payments implemented by input sales are more relevant the larger the difference in marginal costs, since they allow for the shifting of production towards the relatively more efficient firms, while maintaining firms’ incentives to collude. A price of the input above that posted by an alternative source or sales of the input below cost may be observed, depending on the realization of downstream firms’ costs.