Supply shift by a vertically integrated foreign firm under domestic integration

Abstract

This study constructs a vertical structure model where domestic upstream and downstream firms compete with a vertically integrated foreign firm (VIFF), and examines firms’ supply decisions under domestic firms’ separation and integration. We find that the VIFF would switch its supply schedule in both markets, depending on separation and integration, which also shapes different supply decisions of the integrated domestic firm. We demonstrate that industry supply under separation might be socially beneficial if VIFF supplies the final goods, while that under integration decreases welfare unless the number of downstream firm ex-post integration is intermediate. We also examine strategic choices between separation and integration, showing that strategic integration can eliminate these welfare-distortion effects, caused by the VIFF’s switch in its supply decisions, while strategic separation might decrease welfare. Our findings highlight the possible anti-competitiveness of vertical integration when the strategic reactions between the supply shift by the VIFF and domestic integration are relevant.