Vertical Integration as Strategic Behavior in a Spatial Setting: Reducing Rival's Revenues

David Levy and David Reiffen
Working Paper:

This paper provides a formal treatment of how vertical integration may deter entry "by reducing rivals' revenues". We examine a spatial market with the locations of firms fixed due to location-specific (sunk cost) investments at both the upstream and downstream level. We show that vertical integration restricts the potential entrant from selling to its most desirable customers, and thereby enables the upstream firm to expand its market and increase profits without attracting entry. Further, we show that integration is particularly beneficial in a growing and uncertain market, where the ability to integrate enables a firm to wait until future events unfold before any action is taken to deter entry.