Downstream Competition, Foreclosure, and Vertical Integration

This paper analyses the impact of competition among downstream firms on an upstream firm's payoff and on its incentive to vertically integrate when firms on both segments negotiate optimal contracts. We argue that tougher competition decreases the downstream industry profit, but improves the upstream firm's negotiation position. In particular, the upstream firm is better off encouraging competition when the downstream firms have high bargaining power. We derive implications on the interplay between vertical integration and competition among the downstream firms. The mere possibility of vertical integration may constitute a barrier to entry and may trigger strategic horizontal spin-offs or mergers. We discuss the impact of upstream competition on our results.