Vertical’ integration and foreclosure of complementary products. Working paper

Using data from the 128 bit video game industry this paper evaluates the e¤ect of vertical integration and the foreclosure of complementary software to rival hardware. Foreclosure occurs when a console hardware manufacturer produces software which is incompatible with rival hardware. Estimation of video game console demand deviates from previous research by incorporating video game heterogeneity and software com-petition into demand for consolesconsumers di¤erentiate between games rather than assume video games are homogeneous. There are two important trade-o¤s to verti-cal integration. The \u85rst is a foreclosure e¤ect which increases console market power and forces prices higher. The second, an e ¢ ciency e¤ect, drives prices lower. Coun-terfactual exercises determine vertical integration with foreclosure is pro-competitive. It increases price competition as well as consumer welfare and console manufacturer pro ts, and is due to console makers subsidizing consumers in order to increase video games sales, in particular their own developed games, where the greatest proportion o