On the costs and benefits of vertical integration

Abstract

We consider a setting where two upstream firms may vertically integrate or contract with a single downstream distributor. Under vertical integration the integrated firm may offer to share the downstream capacity with its upstream rival. Each firm may or may not have a positive outside option by bypassing the existing distributor. We show that the equilibrium never entails vertical integration and all upstream firms will sign vertical contracts with the common distributor. This result contrasts with results from previous literature, suggesting that vertical integration and sharing can be an equilibrium. Implications for welfare are also considered.