Private And Social Welfare Implications of Buyer Power and Vertical Mergers in Supply Chain Competition
We outline a theoretical model with two upstream and two downstream firms in an imperfectly competitive vertical structure where each upstream firm sells a differentiated product to each downstream firm exclusively. By having a single channel vertically merge while the other channel remaining vertically separated with either a downstream first mover pricing regime or Nash bargaining regime with non-linear tariff we aim to study how integrated profits and social welfare are affected the in presence of product differentiation and bargaining power. We further endogenize channels’ decision to vertically integrate or remain separated, and study whether the Nash equilibrium of this merger game is the socially preferable outcome. We find that a single channel merger is pro-competitive as it eliminates double marginalisation from the channel and consumer surplus is maximum when both channels vertically integrate. Thus vertical integration is welfare enhancing, but need not be the Nash equilibrium of the firms’ strategies.