Inferring the Effects of Vertical Integration from Entry Games: An Analysis of the Generic Pharmaceutical Industry

Abstract

This paper introduces a novel method for examining the eects of vertical integration. The basic idea is to estimate the parameters of a vertical entry game. By carefully specifying rms’ payo equations and constructing appropriate tests, it is possible to use estimates on rival prot eects to make inferences about the existence of vertical foreclosure. I estimate the vertical entry model using data from the US generic pharmaceutical industry. The estimates indicate that vertical integration is unlikely to generate anticompetitive foreclosure eects. On the other hand, signicant eciency eects are found to arise from vertical integration. I use the parameter estimates to simulate a policy that bans vertically integrated entry. The simulation results suggest that such a ban is counterproductive; it is likely to reduce entry into smaller markets.