Defensive vertical merger waves

Abstract This paper examines the competitive and welfare effects of a wave of vertical mergers in a supply chain model where two upstream suppliers, with different marginal costs of production, provide a homogeneous input to three horizontally differentiated retailers. We identify conditions under which a wave of vertical mergers unambiguously improves consumer welfare. Specifically, when the most efficient supplier is the first to integrate and the market is fully covered, the subsequent integration by the less efficient supplier unambiguously benefit consumers irrespective of whether the independent retailer is foreclosed or not. The intuition is that the second merger helps the less efficient supplier establish a protected position in the downstream market, preventing the more efficient competitor from leveraging its cost advantage to create contractual barriers to entry in the upstream market and monopolize the downstream market. If the order of mergers changes, a merger wave may or may not benefit consumers depending on the degree of cost heterogeneity and the degree of product differentiation. Interestingly, when comparing consumer welfare across different market structures — namely, no integration at all, single integration, and a wave of vertical mergers — we show that when a merger wave maximizes consumer welfare, it requires the independent retailer to be foreclosed.