Backwards Integration and Strategic Delegation

The acquisition of ownership rights by a firm in its suppliers is a common feature in various industries. Often, these acquisitions are reduced to a participation in the target's cash flow, and not associated with any control. This form of backwards integration has heretofore not been of great concern to the researchers and practitioners of competition policy. The consensus was that competition would not be harmed by such "silent" acquisitions.

Against this backdrop, we analyze how a non-controlling partial backwards acquisition in the efficient supplier affects up- and downstream prices. When the efficient supplier also sells to downstream rivals, the acquiring downstream firm internalizes that an increase in the rivals’ sales increases upstream profits. Hence the acquiring downstream firm has an incentive to increase its sales price as this increases rivals’ sales. Its rivals react by also increasing theirs - and this the more, the more competitive the downstream industry is.

Full vertical integration, associated with controlling the target’s decisions, instead, leads to decreasing downstream prices as double marginalization is avoided. It is shown to be less profitable than passive backwards integration, as long as competition is sufficiently intense in both, downstream and upstream markets. This has an important implication: When acquiring shares in the upstream firm, downstream firms strategically abstain from vertical control, and with this allow the efficient upstream firm to stick to a high transfer price. This is a very peculiar form of the so-called strategic delegation of decisions.

With this paper, we show that passive partial backwards integration should indeed be of concern to competition authorities.

Hunold, Matthias, Lars-Hendrik Röller and Konrad Stahl (2012), Backwards Integration and Strategic Delegation, ZEW Discussion Paper No. 12-022, Mannheim.