A Fixed Effect Model of Endogenous Integration Decision and Its Competitive Effects

This paper studies endogenous integration decisions of firms and its competitive effects in a complementary market setting where downstream firms sell a product which must have a compatible variety of products that are supplied by upstream firms. I present the conditions under which a downstream firm will prefer integrating with an upstream firm, and conditions under a counter merger of firms occur. The analysis shows that a vertical merger is more likely to occur whenever one of the upstream firm is significantly productive than the other. Competitive effect of a integration of two firms can lead to a counter integration of rivals post integration. Counter integration is likely whenever both upstream firms are highly productive. In addition to a vertical merger and two vertical mergers, contracting under independent ownership can also be the method of procuring. As a result, no integration activity can be observed. The results are obtained in a general two downstream firms and two upstream firms market setting that allows efficient compatibility contracts between upstream and downstream producers.Endogenous Vertical Integration, Positive Externality, Complementary Products, Product Variety