Vertical integration, foreclosure, and productive efficiency

We analyze the consequences of vertical integration by a monopoly producer dealing with two retailers (downstream firms) of varying efficiency via secret two-part tariffs. When integrated with the inefficient retailer, the monopoly producer does not foreclose the rival retailer due to an output-shifting effect. This effect can induce the integrated firm to engage in below-cost pricing at the wholesale level, thereby rendering integration procompetitive. Output shifting arises with homogeneous and differentiated products. Moreover, we show that integration with an inefficient retailer emerges in a model with uncertainty over retailers' costs, and this merger can be procompetitive in expectation.