The treatment of vertical mergers and vertical restraints has been almost as important an issue for competition policy as the development and application of guidelines for horizontal agreements. Traditionally, vertical integration of an input supplier into downstream production has been suspected of reducing competition either in the downstream market or in the upstream market by foreclosing competitors' access to downstream firms. In contrast to this legal tradition it has been widely argued that vertical integration should be ignored altogether by competition policy. This view is based on the observation that the initial problem is caused by a lack of competition at one stage of the supply chain and would therefore best be corrected by inducing more competition at this stage.

In discussion paper No 1293, Research Fellows Kai-Uwe Kühn and Xavier Vives specifically analyse the question of whether competition policy should prevent vertical integration by an upstream firm with market power in order to safeguard downstream competition. The paper provides a systematic analysis of the welfare effects of vertical integration by a monopolistic input supplier into a monopolistically competitive downstream industry. It gives sufficient conditions on consumer preferences that lead to Pareto improving vertical integration, and demonstrates a close relationship between assumptions on preference for variety, excess entry in monopolistically competitive markets, and the welfare effects of vertical integration. Both excess entry and welfare improving vertical integration arise only if preference for variety falls as variety increases for given total output.

Excess Entry, Vertical Integration and Welfare
Kai-Uwe Kühn and Xavier Vives