Double Marginalization and Vertical Integration: New Lessons from Extensions of the Classic Case

Abstract

Although firms have a variety of motives for merger and other restrictions, a traditional issue, which permeates much of the literature on integration, is how the existence of horizontal market power in one or more vertically-related industries creates motives for them to vertically integrate [13, 187-89]. The classic case is double marginalization. Suppose that an upstream industry sells an intermediate good to a downstream industry, which in turn produces a final product that it sells to consumers. Then, because the upstream and downstream industries independently engage in noncompetitive pricing, the firms in each industry only see the effect of their output restriction on their own profits, and do not see that their output restriction also affects the profits of the firms in the other industry. This myopia creates a vertical externality that integration would internalize. In the simplest case, when the products are homogeneous and final production has fixed input proportions, the conventional wisdom about double marginalization is that .. the integrated industry makes more profit than the nonintegrated industry, and the consumer price is lower in the case of the integrated industry. These two properties are very general.. . [15, 175]. The implication is that integration of two noncompetitive industries would not be anticompetitive, contradicting the traditional antitrust hostility toward integration. In fact, what is crucial for double marginalization to have any relevance for antitrust policy is the conjunction of the welfare and profitability properties. No matter how beneficial or damaging a particular behavior might be, if that behavior is unprofitable it has little relevance for antitrust policy, because it either would not occur or would be self-correcting. Rational public policy would not be concerned about what firms have no incentive to do. Consequently, profitability is a crucial methodological requirement of models that analyze integration.