Equilibrium Analysis of Vertical Mergers

Published date01 September 2020
DOI10.1177/0003603X20929138
Date01 September 2020
Subject MatterArticles
Article
Equilibrium Analysis
of Vertical Mergers
Gopal Das Varma* and Martino De Stefano*
Abstract
Vertical mergers are known to potentially create an incenti ve for the merged firm to raise the price of
inputs it supplies to its rivals (rai sing rivals’ cost [RRC]). At the same time, vertical merge rs are known
to create efficiencies in the for m of elimination of double marginalization (EDM). Competitive effects
of vertical mergers are evaluated as the net effect of RR C and EDM. Conventional antitrust tech-
niques treat the two effects—RRC an d EDM—as separable and analyze each in isolation before
evaluating their net effect. We show that in an eq uilibrium treatment, RRC and E DM are not
separable; instead, they are ins eparably linked because the size of EDM is an important deter minant of
the strength of the RRC incentiv e. When the link between EDM and RRC is taken into account,
predicted price effects of a vertic al merger can turn out to be significan tly different relative to those
predicted by conventional tech niques. Under certain commonly u sed assumptions, a vertical merge r
may even create an incentive for the m erged firm to lower its rivals’ cost . The precise price effect
depends on two things: the shape of demand and the bargainin g power of the upstream input supplier
in its price negotiations with d ownstream firms.
Keywords
antitrust, vertical mergers
I. Introduction
Vertical mergers are known to potentially create both competitive harm and competitive benefits.
Both are created by the change in the objective function of the merging firms from own profit
maximization (before the merger) to joint profit maximization (after the merger). On the harm side,
a vertical merger can create incentives for themergedfirmtoraiseitswholesale price to downstream
competitors that buy inputs from it to impair their competitiveness (raising rivals’ costs [RRC]). On
the benefit side, a vertical merger can lead to the elimination of double marginalization (EDM)
between the upstream and downstream merging firms which can lead to a reduction in retail price.
* Charles River Associates, Washington, DC, USA
Corresponding Author:
Martino De Stefano, Charles River Associates, 1201 F St NW #800, Washington, DC 2004, USA.
Email: mdestefano@crai.com
The Antitrust Bulletin
2020, Vol. 65(3) 445–458
ªThe Author(s) 2020
Article reuse guidelines:
sagepub.com/journals-permissions
DOI: 10.1177/0003603X20929138
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