Vertical Integration

Abstract

Economists have long been inquiring into the determinants of vertical integration. Theories which explain the rationale for firms’ decision to expand vertically also predict different implications in terms of welfare. A body of literature traces vertical integration to the problem of the origin and the boundary of a firm and explains integration on the bases of the economization of costs related to market transactions and contract incompleteness; this literature dates back to Coase’s (Economica 4:386–405, 1937) seminal article on the nature of the firm and has been developed within the Transaction Costs Economics framework and subsequently under the Property Right approach. Another set of contributions studies vertical integration with respect to firms’ competitive environment. In this context, two main views emerge: on the one hand vertical integration has been considered as a way to exploit market power and implement (otherwise banned) price or exclusionary strategies and may thus raise antitrust concerns; on the other hand, integrating firms can cope with negative “vertical” externalities and increase efficiency. Another set of contributions, often referred to as vertical equilibrium or dynamic models, explains vertical integration with respect to the degree of market maturity, as the Stigler model, or to demand fluctuations. Other models explain the incentive for vertical integration by factors related to uncertainty, i.e., over the supply of the input good or in the demand of the final good.