Merge and Compete: Strategic Incentives for Vertical Integration

Abstract

Vertical integration followed by quantity competition is studied. In the first stage of the game downstream firms simultaneously decide whether to integrate with one of the upstream suppliers. If firms are not able to observe whether their vertically integrated competitor enters the intermediate-good market then they are indifferent about vertical integration. If the entry choice of the integrated firm is observable then the unique equilibrium involves vertical integration and in-house production of the intermediate good. The importance of entry observability sheds light on the strategic importance of information exchange institutions such as the internet and business fairs.

Keywords: Vertical integration, Cournot competition, Market entry

JEL Classification: L13, L22