In our industrialized world we are confronted with very complex goods. Most of them
became part of our everyday life like cars, planes and so on. These products consist
of several components with high technological requirements to guarantee the quality
of the final product.
For example, the production of a high developed plane, as the Airbus A380, needs
many special single components like turbines, wings, etc. These vital intermediate
goods could either be purchased by foreign firms or be produced by the downstream
assembler itself, respectively by an owned subunit.
A view on the vertical structure among different downstream firms of different products shows that the share in purchased goods from foreign upstream firms varies widely.
Since the components are very specifc, the number of upstream firms which produce
one vital intermediate input is of course limited. In turn, the specific component
could be purchased by less, mostly just one, consumer. A turbine manufactured for
the A380, for instance, could not be used by another assembler than Airbus.
A downstream firm is faced by deciding whether it should either integrate upstream
units and become the owner of them or to sell some upstream firms, respectively let them stay independent, with respect to maximize its own profit.
To provide an answer to the optimal behavior of an assembler, with respect to in-
tegrate or to separate upstream units, I will use a model where the downstream
firm is a monopolist in the final good market and needs a fixed number of vital intermediate inputs in fixed proportions to produce the final product. This model is relatively new and not being discussed by many authors. It was first examined in 2008 by Laussel.
We will see that there exist two effects that influence the decision of the downstream firm. If the independent upstream suppliers have some positive bargaining power, they will sell their produced goods to a price above their costs. That causes the double marginalization effect, because the upstream firms do not account for the effect of its mark-up on the downstream firm. Furthermore an independent supplier, with a positive bargaining power, has a decreasing effect on the prices of the components supplied by the other independent upstream firms, because of the perfect complementary character of the intermediate goods. A high number of independent suppliers yields to relatively low input prices of the particular upstream firms.
Table of Contents
1 Introduction
2 The Model
2.1 Assumptions
2.2 Profits
2.3 Effects
3 Laussel (2008)
3.1 Exogenous partial backward integration
3.2 Endogenous backward integration
4 Matsushima and Mizuno (2009)
4.1 Separation under full bargaining power
4.2 Separation under variable bargaining power
4.3 Separation with multiple periods
5 Laussel and Van Long (2011)
5.1 Separation when the downstream firm can commit
5.2 Markov-perfect equilibrium
6 Conclusion
Research Objectives and Themes
This work examines the optimal strategic decision-making process for a monopolistic downstream assembler regarding the vertical integration or separation of its upstream suppliers, specifically for vital intermediate inputs produced in fixed proportions. The research evaluates how bargaining power, competition among suppliers, and dynamic market expectations influence whether an assembler should integrate or separate units to maximize its profit, addressing the "double marginalization" effect and the strategic implications of market structure.
- Analysis of vertical structure between a monopolist and multiple upstream suppliers.
- Evaluation of double marginalization and its impact on supplier integration incentives.
- Dynamic modeling of asset price expectations and optimal sale policies for upstream units.
- Comparison of static one-shot models versus Markov-perfect equilibrium approaches.
- Assessment of the "business stealing" effect and its role in supplier separation.
Excerpt from the Book
1 Introduction
In our industrialized world we are confronted with very complex goods. Most of them became part of our everyday life like cars, planes and so on. These products consist of several components with high technological requirements to guarantee the quality of the final product.
For example, the production of a high developed plane, as the Airbus A380, needs many special single components like turbines, wings, etc. These vital intermediate goods could either be purchased by foreign firms or be produced by the downstream assembler itself, respectively by an owned subunit.
A view on the vertical structure among different downstream firms of different products shows that the share in purchased goods from foreign upstream firms varies widely. Since the components are very specific, the number of upstream firms which produce one vital intermediate input is of course limited. In turn, the specific component could be purchased by less, mostly just one, consumer. A turbine manufactured for the A380, for instance, could not be used by another assembler than Airbus.
A downstream firm is faced by deciding whether it should either integrate upstream units and become the owner of them or to sell some upstream firms, respectively let them stay independent, with respect to maximize its own profit.
Summary of Chapters
1 Introduction: Provides an overview of the complex vertical structure in industrial production and introduces the research problem regarding the assembler's decision between integration and separation.
2 The Model: Establishes the formal mathematical framework, including production functions and profit maximization problems, to analyze the effects of independent versus integrated suppliers.
3 Laussel (2008): Reviews static literature on partial backward integration and examines whether mergers are profitable under exogenous and endogenous game-theoretic conditions.
4 Matsushima and Mizuno (2009): Extends the analysis to static scenarios with variable bargaining power and explores the implications of multi-period trading on separation strategies.
5 Laussel and Van Long (2011): Develops a dynamic, time-consistent approach using Markov-perfect equilibrium to model the assembler's optimal, long-term sale policy for its assets.
6 Conclusion: Synthesizes the findings, noting that the optimal strategy depends heavily on the initial state of integration and market expectations regarding future competitor behavior.
Keywords
Vertical Integration, Upstream Suppliers, Monopolistic Assembler, Double Marginalization, Bargaining Power, Strategic Separation, Markov-perfect Equilibrium, Complementary Inputs, Asset Pricing, Market Expectations, Vertical Structure, Industrial Economics, Game Theory, Business Stealing Effect, Dynamic Modeling
Frequently Asked Questions
What is the primary subject of this research?
The research explores the optimal organizational strategy for a monopolistic downstream firm when interacting with suppliers of vital intermediate components, focusing on whether it is more profitable to integrate these suppliers or allow them to remain independent.
What are the central themes discussed?
The central themes include the trade-offs between vertical integration and separation, the impact of the double marginalization effect, supplier bargaining power, and the importance of time-consistency in dynamic strategic planning.
What is the primary research goal?
The goal is to determine the optimal degree of supplier integration or separation for an assembler to maximize long-term profits, considering both static economic models and dynamic market expectations.
Which methodology is employed?
The work utilizes mathematical modeling and game theory, specifically analyzing Nash equilibria in one-shot games and Markov-perfect equilibria for dynamic, multi-period scenarios.
What topics are covered in the main section?
The main sections cover the formal modeling of production and profit, reviews of existing literature (Laussel, Matsushima, Mizuno), and a detailed derivation of optimal sale policies for upstream units in a dynamic framework.
Which keywords characterize this work?
Key terms include vertical integration, double marginalization, Markov-perfect equilibrium, bargaining power, and strategic separation.
Why does the assembler sometimes prefer to separate rather than integrate?
Separation can be beneficial because maintaining independent suppliers fosters competition among them, which can keep input costs lower than if the assembler were to consolidate and eliminate that competitive pressure.
What is the role of market expectations in this model?
Market expectations are crucial because they dictate the asset prices of upstream firms; if buyers anticipate that an assembler will continue to sell assets, they will not pay a premium, which constrains the assembler's strategy and forces a time-consistent approach.
What is the "junction point" in the Markovian strategy?
The junction point is a specific condition for the number of integrated firms where the assembler uses a mixed strategy, either selling all assets immediately or keeping them, to maintain a rational expectation equilibrium.
- Quote paper
- Alexander Max (Author), 2013, Optimal separation of upstream suppliers of vital intermediate inputs by a monopolistic assembler, Munich, GRIN Verlag, https://www.grin.com/document/214540
