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Evaluating the Evidence on Vertical Mergers

Abstract

In theory, vertical mergers can have both procompetitive and anticompetitive effects. Many early empirical studies found benefits for vertical relationships; but the seminal surveys of this literature are now over a decade old. We review the empirical evidence from the last decade on vertical integration—as well as that in two frequently cited surveys from the mid-2000s. Taken as a whole, the empirical evidence as to the change in welfare that is due to vertical mergers is decidedly mixed, and should certainly not be used as a basis for a presumption that most vertical mergers are procompetitive or harmless.

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Notes

  1. See U.S. Department of Justice and Federal Trade Commission (2020).

  2. Many published evaluations of vertical mergers and vertical relationships conclude with statements that summarize past transactions and that do not make a direct link to a change in policy. Nonetheless, these results are often used in a policy context – on panels, or in speeches, or in footnotes as evidence – to justify an easing of enforcement standards with respect to vertical mergers.

  3. Lafontaine and Slade (2008) are also frequently cited as part of the discussion of benefits of vertical relationships. That paper focuses on non-merger-related vertical restraints – such as resale price maintenance, exclusive dealing, exclusive territories, quantity forcing, and tying – which are not covered by the Vertical Merger Guidelines.

  4. Specifically, we start with the 30 (after removing duplicates) studies that are listed in Tables 15–17 of Lafontaine and Slade (2007, pp. 672–676). That survey also reviews numerous other studies in Tables 1–14 that are concerned with explaining the incidence, rather than the consequences, of vertical integration (Lafontaine and Slade, 2007, p. 671). Those studies are excluded from our review. We then consider Table 1 of Cooper et al. (2005, p. 648), which encompasses all of the studies in that survey – including analyses of both vertical integration and vertical restraints. After removing the studies that duplicate those in Tables 15–17 of Lafontaine and Slade (2007) and that concern restraints other than full integration – e.g., partial ownership, exclusive dealing, resale price maintenance, exclusive territories, etc. – we arrive at 31 total studies.

  5. A third article that was not included in the surveys – Goolsbee (2007) – uses a cross-sectional approach without instrumental variables and finds no clear evidence of efficiencies for a cable channel that has a larger fraction of its subscriber base associated with its integrated partner’s cable service.

  6. Another article that was not included in the surveys considers vertical integration among railroads. Grimm et al. (1992) test the single monopoly profit theory – that a monopolist has no additional market power to gain from foreclosure through vertical merger – and find that it did not hold for railroad markets. When the single monopoly profit theory does not hold, a vertical merger may provide an incentive to foreclose unintegrated competitors.

  7. This result is consistent with the findings of Luco and Marshall (2020), which will be discussed in the next section. However, Luco and Marshall (2020) also find that acquired bottlers increase the prices of rival soft drinks (that are not manufactured by the acquiring firm) that they bottle.

  8. Two other articles that were published in the same year – but were not included in the surveys – conduct longitudinal studies of the effect of hospital-physician integration on hospital pricing. Cuellar and Gertler (2006) find that higher hospital prices are associated with vertical integration based on 1994–1998 inpatient claims data from Arizona, Florida, and Wisconsin; while Ciliberto and Dranove (2006) find no significant effect on hospital prices based on 1994–2001 inpatient claims data from California. As will be discussed in the next section, later studies find integration between hospitals and physicians to be correlated with increased hospital and physician prices and patient spending (Baker et al., 2014; Capps et al., 2018), but not with health outcomes (Koch et al., 2020).

  9. This sample of studies is not intended to be an exhaustive list of every relevant article written in the last decade. Nonetheless, the number of articles that find evidence of harm and benefits from vertical mergers is enough to suggest that the empirical economic literature, like the theoretical literature, supports a variety of possible effects from vertical mergers.

  10. Taylor et al. (2010) use data from the Oil Price Information Service (OPIS). The OPIS data also cover station-level gas prices, but the distribution of the stations that are sampled differs from that used by Hastings (2004). Neither dataset is representative of the true underlying distribution (according to the California Energy Commission), but the sample from Hastings (2004) comes closer (see Taylor et al., 2010, Table 1).

  11. Taylor et al. (2010, p. 1269) note:

    Our results also cast doubt on the underlying model of consumer preferences (differentiated products with consumer brand loyalty) for which Hastings finds support in her data. Even if this model accurately depicts consumer behavior, we note that its welfare effects are ambiguous because the introduction of a new brand increases gross consumer utility. Hastings describes how rebranding can soften price competition but makes no claims as to welfare effects.

  12. See Austin (2015, p. 2061).

  13. Austin (2015, p. 2060) explains:

    When multiple retailers in the same market are owned by the same price setter (such as an integrated oil company), the stations can be considered different products of a multi-product firm and they would have higher prices than they would otherwise in order to reduce cannibalization between the substitutable products, potentially resulting in a price increasing effect of vertical integration.

  14. This paper mentions a test of prices at competitor gas stations, but it does not provide details about the regression specification or show a table of results. It simply states that the test shows that competitors of vertically integrated stations priced their gasoline 1.9 cents per gallon lower than did competitors of non-integrated stations. However, the paper notes that “many of the competitors’ stations are likely to themselves be lessee operated,” which would imply that they were unlikely to buy gasoline from the vertically integrated competitor and therefore unlikely to be the targets of input foreclosure incentives. See Austin (2015, p. 2063).

  15. Discussing the results of Crawford et al. (2018) and their interpretation of the literature, Crawford et al. (2019, p. 4) come to two conclusions: “(i) foreclosure is a real phenomenon that could lead to welfare losses; and (ii) the ‘jury is still out’ on the likelihood of pro vs. anticompetitive effects being the dominant force in the types of markets where vertical mergers are likely to be challenged.”

  16. Vertical contracts tend to decrease hospital admissions, but the relationship is only statistically significant for open physician-hospital organizations, which are defined as contracting relationships (not ownership) that are generally open to all members of the medical staff who wish to participate. The effect on spending for these hospitals is not significantly different from zero despite the decrease in admissions.

  17. Neprash et al. (2015) also assess the impact of hospital-physician integration on physician prices, but at a metropolitan statistical area (MSA) level. Estimating the MSA’s extent of vertical integration based on the share of physician CMS billings reported as occurring at hospital facilities, they find that integration is associated with higher prices for physician outpatient services that are provided to commercially insured patients.

  18. Robinson and Miller (2014) also consider the effect of hospital-physician integration on total expenses per patient (including insurance payments for professional services, inpatient and outpatient procedures, diagnostic tests, and pharmaceuticals), but they use a cross-sectional approach. For a group of patients in California covered by commercial health maintenance organization (HMO) insurance, they estimate that per-patient expenditures were 10% to 20% higher for patients who were associated with hospital-owned physician organizations than for those who were associated with physician-owned organizations.

  19. The degree of concentration is measured as the weighted average of zip-code specific HHIs (based on physician practices that serve patients in the zip code) for zip codes that are near the physician’s practice and account for a majority of the practice’s patient billings.

  20. Coordination is not tested directly. Hanssen (2010, p. 521) explains: “Because the precise nature—or even existence—of any [explicit or implicit collusive] arrangement cannot be observed (being, by definition, extracontractual), I proceed by indirection. Was vertical integration associated with a greater probability of ex post run-length renegotiation, ceteris paribus?”

  21. To control for unobservable theater characteristics that might have led to integration in the first place, this specification allows for price differences between the group of theaters that were ever integrated and the group of theaters that were always independent. Note that the article also examines the effect of integration on theater admissions, which are estimated as total revenue divided by the evening ticket price. However, this measure may over- or under-estimate the actual change in admissions – depending on relative changes in the evening and matinee prices.

  22. See Luco and Marshall (2020, p. 2043).

  23. Similar benefits can arise when a single entity becomes the owner of two complementary goods, even if one good is not an input to the other. However, given that the integrated goods in this study belong to different levels of the supply chain, it is not clear that customers would use them in a complementary manner.

  24. Atalay et al. (2014, p. 1140) conclude: “much of what makes establishments in vertical ownership structures different isn’t really related to vertical ownership itself. Instead, the largest establishments tend to be in the largest firms, and the largest firms tend to own vertically linked establishments.”

  25. Atalay et al. (2014, p. 1146) explain:

    [T]here may not be anything particular about vertical structure within firms; intangible inputs can flow in any direction across a firm’s production units. Vertical firm structures and expansions may not be fundamentally different from horizontal structures and expansions. Instead, a more generalized view of firm organization, like the firm as an outcome of an assignment mechanism that matches heterogeneous tangible and intangible inputs, may be warranted, and is consistent with some of the other patterns we document in the data.

  26. Demand is measured as the share of platform owners who have not already purchased the game and who purchase it during the current period. Price is often instrumented with the average time that it takes the price of other games within the same genre and platform to drop 60% from their level at release.

  27. Lee (2013) builds a model of consumer demand in the video game industry and finds that, holding the set of games fixed, the elimination of all vertical integration and exclusive contracts between platforms and games increases consumer welfare. His model does not distinguish between contractual exclusivity and full vertical integration, so it is not clear whether this welfare impact would be relevant to a merger. He also finds that vertically integrated games have higher quality for consumers, but his model does not attempt to determine whether quality differences are the result of vertical integration or of the selection of higher quality games for exclusive relationships.

  28. The study measures IT adoption based on the Harte Hanks Market Intelligence survey. Forman and Gron (2011, p. 198) define business electronic commerce and extranet as IT that is related to ‘insurer-agent communication’ and commerce, home electronic commerce, customer service, education, and publishing applications as IT that is related to ‘consumer applications.’ The hypothesis is that frictions – independent agents who act in their own interest rather than in the insurer’s interest (which would affect consumer applications), and transaction costs that are associated with serving multiple insurers (which would affect insurer-agent communication) – slow IT adoption for non-vertically-integrated firms.

  29. The model focuses on system-on-chips that contain application processors that are combined with other integrated circuits, rather than on modem chips that Apple does source from Qualcomm (Yang, 2020, p. 745).

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Acknowledgements

We thank Steven Salop and Michael Salinger for helpful comments. All opinions in this paper are the views and opinions of the authors and do not reflect or represent the views of Charles River Associates, of any other individuals who are affiliated with Charles River Associates, or of any other organizations with which the authors are affiliated.

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Beck, M., Scott Morton, F. Evaluating the Evidence on Vertical Mergers. Rev Ind Organ 59, 273–302 (2021). https://doi.org/10.1007/s11151-021-09832-z

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Keywords

  • Antitrust
  • Competition policy
  • Merger
  • Vertical merger