Journal ofAgricultural and Resource Economics 24(1):1-18 Copyright 1999 Western Agricultural Economics Association A Strategic Rationale for Captive Supplies

Partial backward integration is prevalent in many agricultural and natural resource processing industries. A strategic rationale for partial backward integration is developed for a dominant firm with a competitive fringe purchasing from competitive input suppliers. A partially backward integrated dominant firm potentially can increase profit through production efficiency gains and through a lower price for externally purchased input. The optimal degree of backward integration results when the dominant firm's profit from exerting monopsony market power in the external spot market equals its profit from producing raw input internally, less the incremental cost of acquiring internal raw input production capacity. Comparative statics results are consistent with recent empirical studies of the beef packing industry. Key words: backward integration, captive supplies, dominant firm, fringe firms, meat packing, monopsony, price discrimination, vertical integratio