The Nonequivalence of Vertical Merger and Exclusive Dealing

Abstract

The economic and legal view of vertical integration has varied over time, but, a constant source of concern is the fear that the integrated firm will foreclose competitors from intermediate markets. At the same time, most commentators have considered the economics of vertical contracts, especially exclusive dealing, to be essentially identical to vertical merger. Using the simple model of Comanor and Freeh [Comanor, William S. and Freeh, H.E., III, “The Competitive Effects of Vertical Agreements?” American Economic Review, June 1985, 75, 3, 539-46], it is shown that vertical mergers and exclusive dealing contracts are not behaviorally equivalent. In particular, vertical mergers will not lead to foreclosure of rivals for anticompetitive reasons, while ordinary exclusive dealing contracts will lead to such anticompetitive foreclosure. Vertical mergers avoid certain externalities that exclusive dealing contracts create. In this model, vertical mergers can only cause anticompetitive problems through their horizol aspects, by creating a monopoly of distributors. Of course, merger can always be mimicked by a complex enough contract between nominally independent parties. In this model, the contracts that mimic the merger require two parties to agree on the price of a third party's products and are particularly subject to being undermined by price-cutting. Thus, it is likely to be uncommon.