Equilibrium Analysis of Vertical Mergers

• Author: Martino De Stefano,Gopal Das Varma
• DOI: 10.1177/0003603X20929138
• Published date: 01 September 2020
• Date: 01 September 2020

Article

Equilibrium Analysis

of Vertical Mergers

Gopal Das Varma* and Martino De Stefano*

Abstract

Vertical mergers are known topotentially 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). Competitiveeffects

of vertical mergers are evaluated as the net effect of RRC and EDM. Conventional antitrust tech-

niques treat the two effects—RRC and EDM—as separable and analyze each inisolation before

evaluating their net effect.We show that in an equilibrium treatment, RRC and EDM 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 incentive. When the link between EDM and RRCis taken into account,

predicted price effects of a vertical merger can turn out to be significantly different relative to those

predicted by conventional techniques. Under certain commonly used assumptions, a vertical merger

may even create an incentive for the merged firm to lower its rivals’ cost. The precise price effect

depends on two things: the shapeof demand and the bargainin g power of the upstream input supplier

in its price negotiations with downstream 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 RiverAssociates, 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

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DOI: 10.1177/0003603X20929138

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