Up Next

ki-logo-white
Market-Based Solutions to Vital Economic Issues

SEARCH

ki-logo-white
Market-Based Solutions to Vital Economic Issues
Research
Jan 1, 2014

Vertical Integration under Competition: Forward, Backward or No Integration

Abstract

We consider two competing supply chains, each consisting of supplier, a manufacturer, and a retailer. The suppliers exert effort to improve product quality, and the retailers sell products competitively. Each manufacturer chooses one of the three strategies: forward integration, backward integration, or no vertical integration. We seek for a subgame perfect Nash equilibrium and study the resulting market structure. Moreover, we characterize the effect of vertical integration on profitability, product price, and quality in a competitive setting. Existing literature has shown that, when manufacturers consider only forward integration, they may choose not to vertically integrate in equilibrium. In contrast, we find that, when both forward and backward integration options are considered, disintegration cannot be an equilibrium outcome. In this case, both manufacturers either forward or backward integrate, and the degree of product perishability, cost of quality, and how much consumers value quality are critical for the chosen direction of integration. Furthermore, competition increases attractiveness of backward integration relative to forward integration. We show that, while integrating backward unilaterally is always beneficial, unilateral forward integration can harm a manufacturer’s profitability. Finally, vertical integration can result in a better quality product sold at a lower price.


View Publication on UNC Library View Publication on Journal Site

You may also be interested in: