Vertical integration: Antitrust Implications

Except for the rather special case where a regulated firm has integrated backward into equipment supply, which needs to be assessed in the context of the regulatory milieu, vertical integration poses antitrust issues of two kinds: price may be adversely affected and the condition entry may be impaired. It needs, however, to be appreciated that adverse effects of neither kind will obtain unless a nontrivial degree of monopoly exists. Accordingly, the enforcement of antitrust with respect to vertical integration ought to be restricted to the monopolistic subset. Elsewhere, the maintained hypothesis ought to be that vertical integration has been undertaken for the purpose of economizing on transaction costs.

Although the price in the downstream market may change as a result of forward integration by a monopolist, the direction of the change cannot be established without knowledge of particular firm and market circumstances (see Section 1.3 of Chapter 5). Likewise, the welfare implications of price discrimination cannot be established without knowledge of underlying demand relations and the transaction costs of effecting differential prices.

By contrast, the condition of entry is less subject to such welfare ambiguities: integration by an established firm into a second stage will rarely make access to a potential entrant into either stage easier; and impeded entry, ceteris paribus, generally has disadvantageous welfare consequences.

However, except in dominant firm (or otherwise very concentrated) industries or in moderately concentrated industries where collusion has been successfully effectuated, vertical integration is unlikely to raise entry impediments. Moreover, since, for the reasons given in Chapter 12, collusion in moderately concentrated industries is difficult to achieve, very concentrated industries in which the bulk of production is accounted for by integrated firms constitute the policy-relevant subset of principal concern.

Entry impediments of two types can arise where the leading firms in stage I integrate (backward or forward) into what could otherwise be a competitively organized stage II activity. For one thing, the residual (nonintegrated) sector of the market may be so reduced that only a few firms of efficient size can service the stage II market. Firms that would otherwise be prepared to enter stage I may be discouraged from coming in by the prospect of having to engage in small-numbers bargaining, with all the hazards that this entails, with these few nonintegrated stage II firms. Additionally, if prospective stage I entrants lack experience in stage II related activity, and thus would incur high capital costs were they to enter both stages themselves, integrated entry may be rendered unattractive. The integration of stages I and II by leading firms is then anticompetitive, in entry aspects at least, 65 if severing the vertical connection would permit a competitive (large-numbers) stage II activity to develop without loss of scale economies.

Vertical integration in industries with low to moderate degrees of concentration does not, however, pose these same problems. Here a firm entering into either stage can expect to strike competitive bargains with firms in the other stage whether they are integrated or nonintegrated.66 The reasons are that no single integrated firm enjoys a strategic advantage with respect to such transactions and that collusion by the collection of integrated firms (in supply or demand respects) is difficult to effectuate. Vertical integration rarely poses an antitrust issue, therefore, except as the industry in question is highly concentrated or, in less concentrated industries, collective refusals to deal are observed. But for such circumstances, vertical integration is apt to be of the efficiency promoting kind.

Source: Williamson Oliver E. (1975), Markets and hierarchies: Analysis and antitrust implications, A Study in the Economics of Internal Organization, The Free Press.

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