Integration and Competition in the Petroleum Industry

By Melvin G. De Chazeau; Alfred E. Kahn | Go to book overview

CHAPTER 17
The Impact of Size and Integration on Product Prices: I

THE PHENOMENON of vertical integration may properly be conceived in two almost diametrically opposing ways. On the one hand, it may be regarded as the reflection of an essentially conservative, anticompetitive strategy; its goal is security and its tactic is staking out and insulating market position against the competitive uncertainties of open intermediate markets. On the other, it may be accepted as an essentially competitive undertaking -- to do more effectively what the market seems to accomplish inadequately. The economist who relies on static models of the theory of the firm might respond that there is no contradiction between these two views, but only a confusion of monopoly power -- which is the consequence of relative size and fewness of sellers at any given horizontal stratum of an industry and which alone may be conducive to conservative policy and high price -- and vertical integration, which in itself conduces to neither. And in part this answer is valid; there is nothing incongruous or contradictory about even a monopolist attempting by vertical integration to cut his costs and increase the intensity of his selling efforts. But integration in this industry has developed to permit (horizontally) dominant companies to protect their market position against dynamic competitive erosion by making it less necessary to raise price to increase supplies, or reduce price to attract customers. In the process, they have acquired a capacity to reduce sales prices that goes beyond that of the nonintegrated firm, which acquires its supplies not at cost but at market price. The baffling question is, what is the net outcome, on balance, of these potentially contradictory purposes -- reduction in costs or entrenchment of market position?

The net effect of integration on price depends on how strongly it has entrenched market position as measured at a given industry level. The weaker this effect, the more likely it will be that the possible benefits derived from obtaining supplies at lower cost will be shared with consumers. The present chapter analyzes the tendencies inherent in spreading integration to render market competition less intense, and hence to increase the likelihood of higher prices through leader-

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