Downstream Competition, Foreclosure, and Vertical Integration

This paper analyzes the impact of competition among downstream firms on an upstream firm's payoff and on its incentive to vertically integrate when firms in both segments negotiate optimal contracts. We argue that as competition becomes more intense, the upstream firm obtains a larger share of a smaller downstream industry surplus. The upstream firm may encourage competition (even excessively) in response to high downstream bargaining power. The option of vertical integration may be a barrier to entry and may trigger strategic horizontal spin-offs or mergers. We extend the analysis to upstream competition