In his 1950 paper ‘Vertical Integration and Antitrust Policy’, Spengler posited that vertical mergers could lead to lower consumer prices, by addressing the problem of ‘double marginalisation’. In essence, he argued that vertical integration could rid industrial value chains of ‘costly middlemen’, lowering production costs and reducing final prices.
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What are the different types of value chain integration?
Industrial economics broadly distinguishes between two types of value chain integration. First, horizontal integration, which involves the merging of companies operating in the same part of a value chain (e.g. merger of two copper rod producers). And second, vertical integration, which refers to the combination of firms operating in different stages of production (e.g. merger of a rod producer and a cable manufacturer).
A key concern of antitrust policy is that mergers that result in either type of integration, have the potential to undermine market competition, resulting in higher prices and other socially adverse outcomes. Spengler’s contribution was to highlight that, in the aftermath of extensive horizontal integration, vertical integration could actually lower prices.
The problem of double marginalisation
Consider a scenario in which horizontal integration within the copper rod market has weakened competition between rod producers. As a result, rod manufacturers demand an above-competitive price for their rods, pushing up the costs of cable producers. A portion of these heightened costs is then passed on to cable consumers, resulting in higher final prices.
Under these market conditions, imagine the impact of a merger between a rod producer and a cable manufacturer. The cable manufacturer no longer needs to pay the ‘excessive’ surcharge to the rod producer. Consequently, the cable manufacturer’s production costs drop and a portion of these cost savings are transferred to cable consumers via lower prices. In other words, optimizing profit across both stages of production simultaneously, as opposed to independently (‘double marginalisation’), could lower prices for consumers.
Conclusion
Spengler’s paper marked a significant milestone in the evolution of antitrust practice. But it shouldn’t be interpreted to imply that vertical integration never harms consumers. Accordingly, authorities should evaluate the market impact of vertical mergers on a case-by-case basis.
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