Why do large firms tend to integrate vertically? – asymmetric vertical integration reconsidered –
We provide a theoretical framework to discuss the relation between firm size and vertical structures. The framework is based on a Hotelling model with three downstream and three upstream firms. Each downstream firm procures its input from each upstream firm and the procurement problems affect the locations of the firms. We show that the downstream firm that has the largest market share is more likely to integrate vertically. In other words, integrated firms tend to have a large market share. We also show that vertical integration enhances the degree of product differentiation. As a result, vertical integration mitigates the competition among the downstream firms. We briefly discuss whether inefficient downstream firms tend to integrate vertically. We conclude that this is true because those downstream firms tend to be far away from those rival firms and vertical integration enables downstream firms to escape tough competition.