Vertical Integration and Market Structure

Competition Policy and Antitrust

Article Snapshot

Author(s)

Timothy Bresnahan and Jonathan Levin

Source

NBER Working Paper #17889, 2012

Summary

This paper shows how, in some settings, organizational economics and industrial organization economics are entangled.

Policy Relevance

Industry consolidation may be a consequence not only of collusion or features of a particular industry’s market; it might also result from firms’ internal contracting issues.

Main Points

  • Economists distinguish between organizational economics—the economics of a firm’s internal organization—and industrial organization (IO), the study of how firms in a market interact and organize.

    • For example, organizational economics typically studies topics like CEO pay and contract types, and how employers might design contracts that will be accepted by high-ability workers while dissuading low-ability workers.
       
    • Industrial organizational problems include how firms change prices to deter other firms from entering their markets, and how firms might attempt to collude in order to control prices.
       
  • Many problems have both organizational and IO aspects that should be considered in tandem. This is rarely done.
     
  • Both organizational economics and IO consider firm boundaries and their decision to integrate vertically.

    • A vertically-integrated firm combines different steps of the production of a final product. For example, a vertically-integrated power plant might own a nearby coal mine, while a vertically-disintegrated power plant might buy coal from a coal mine owned by a different firm.
       
    • The decision to vertically integrate is contingent on both contracting issues—will an independent coal mine provide a steady stream of coal, or try to extort additional money from the power plant during peak hours?—and IO considerations. For example, securing its own coal mine might allow the power plan to force competitors out of its market by curtailing their coal supply.
       
  • Deciding how to organize research firms similarly encompasses both IO and organizational concerns.

    • There may be advantages to a firm from integrating large numbers of research teams, and large firms may be able to share expensive research equipment across teams. This is an IO concern.
       
    • On the other hand, it might be that creating one large research firm would result in groupthink and less original research, an organizational consideration.

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