Do Vertical Mergers Facilitate Upstream Collusion?∗

In this paper we investigate the impact of vertical mergers on upstream firms’ ability to sustain collusion. We show in a number of models that the net effect of vertical integration is to facilitate collusion. Several effects arise. When upstream offers are secret, vertical mergers faciliate collusion through the operation of a foreclosure effect: Cheating unintegrated firms can no longer profitably sell to the downstream affiliates of their integrated rivals. When offers are public, vertical integration also facilitates collusion through a reaction effect : the vertically integrated firm’s ‘contract’ with its downstream affiliate can be more flexible and thus allows a swifter reaction in punishing defectors. Offsetting these two effects is a possible punishment effect which arises only if the integrated structure is able to make more profits in the punishment phase than a disintegrated structure.