Buyer Power and the Effect of Vertical Integration on Innovation

Our article investigates the impact of vertical integration (without foreclosure) on innovation. We compare cases where either (i) two manufacturers or (ii) a manufacturer and a vertically integrated retailer invest. Then, the independent manufacturer(s) and the retailer bargain over non-linear contracts before selling to consumers. We show that vertical integration always increases the incentives to invest on the integrated product which stifles (resp. spurs) the investment of the independent manufacturer when spillovers are low (resp. high). Instead, when investments are sequential, if buyer power is high, the leader independent manufacturer invests more (resp. less) to discourage the retailer’s investment when spillovers are low (resp. high). Overall, vertical integration is always profitable but only desirable for industry and welfare when the buyer power is high