The Effects of Vertical Organization on the Pricing of Differentiated Products

By Shi, Guanming; Chavas, Jean-Paul | Journal of Agricultural and Resource Economics, December 2011 | Go to article overview

The Effects of Vertical Organization on the Pricing of Differentiated Products


Shi, Guanming, Chavas, Jean-Paul, Journal of Agricultural and Resource Economics


We investigate differentiated product pricing and the effects of vertical organization under imperfect competition. We rely on vertical measures of concentration (termed VHHI) to study how the exercise of market power varies with substitution/complementarity relationships among products and vertical structures. This approach is applied to U.S. soybean seed pricing under vertical integration versus licensing. We find evidence that vertical organization affects seed prices, with an impact ranging from 1.87% to 13.6% of the mean price. These effects vary by institutional setup.We also find that complementarity can mitigate price enhancements associated with market concentration.

Key words: biotechnology, imperfect competition, pricing, seed, soybean, vertical structures

(ProQuest: ... denotes formulae omitted.)

Introduction

Many researchers have examined the role of market power exercised by firms in vertical structures,1 but the implications of vertical control remain a subject of debate (e.g., Tirole, 1992; Whinston, 2006). One school of thought argues that greater vertical control leads to efficiency gains, while other researchers raise lingering concerns about potential adverse welfare effects of vertical control and possible efficiency losses associated with reduced competition (e.g., Whinston, 2006; Rey and Tirole, 2008).

Adding differentiated products to the analysis of vertical organization further complicates matters. Previous work has often avoided this issue by focusing on monopolies or on perfect substitutes in upstream and/or downstream markets (e.g., Hart and Tirole, 1990; Ordover, Saloner, and Salop, 1990; O'Brien and Shaffer, 1992). However, product differentiation is commonly found in vertical channels (see Hastings (2004) for the case of gasoline). This raises questions about how to analyze the effects of vertical organization on pricing differentiated products. The objective of this paper is to study the linkages between vertical structures and pricing under product differentiation by using a Cournot model of multi-product firms to examine the relationship between price margins, vertical organization, and market concentrations.

A key aspect of our analysis involves the characterization of vertical market concentrations under product differentiation. One approach has been to rely on the Herfindahl-Hirschman Index (HHI) to assess horizontal market concentration (e.g., Whinston, 2006). Our analysis extends this index by developing a vertical HHI (termed VHHI), which captures the ways market concentration and vertical organization interact to influence the exercise of market power and, consequently, the prices of differentiated products.

Adapting HHI measures to the analysis of vertical organization is not new. McAfee et al. (2001) and Gans (2007) studied how HHI-type measures can be used to examine the effects of vertical mergers, but their analyses focused on the case of a single consumer good. The VHHI concentration measures used in our analysis apply to vertical organization under differentiated products.2 The usefulness of the approach is illustrated in an econometric application to pricing in the soybean seed industry. The VHHI measures provide valuable insights into the effects of vertical integration under product differentiation.

The soybean seed market makes an excellent case study. Recent advances in biotechnology have led agricultural biotech firms to differentiate their seed products through patented genetic materials either individually (often referred as "single-trait") or in bundled form (often referred as "stacked traits"). In addition, mergers and acquisitions in the U.S. soybean seed industry in the last two decades have changed the industry's horizontal and vertical structures, and markets for soybean seeds have become increasingly concentrated. In the late 1980s, the four largest firms accounted for 40% of the soybean seed market, a substantial rise from 5. …

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