Content
Vertical integration refers to a company’s ownership and control of different adjacent stages of a supply chain, and it is a key firm strategy in the increasingly industrialized agri-food marketing system. Reasons for vertical integration include increased efficiencies due to reduced production and transaction costs, improved quality control, and solution to problems arising from opportunistic behavior and market power at successive stages of the supply chain.
Despite the potential positive impacts of vertical integration, there have been legislative and regulatory efforts to abolish this vertical market arrangement in the US pork industry, as well as other industries. A key argument against vertical integration is an alleged increase in the market power of vertically integrated firms and its negative impacts on non-integrated firms, consumers and hog producers. While there can be cases where vertical integration can reduce rivals’ access to some valuable resources, the market power argument against vertical integration seems to be based on the impacts of horizontal integration (i.e., the integration of firms at the same stage of production), which can, indeed, increase market concentration and the market power of the horizontally integrated firms. The impacts of vertical integration and, thus, of its abolishment, on the other hand, are more nuanced and more complex as there are multiple reasons for firms to vertically integrate and, thus, multiple states of nature that can result from the abolishment of this vertical market arrangement.
CAFIO-PRG Research
The determination of the economic, market and welfare impacts of removing vertical integration from the US pork industry is the key objective of a study we completed recently. To determine the market and welfare impacts of abolishing vertical integration, we developed an empirically relevant multi-market framework of analysis of vertical relationships in pork production that disaggregates the output and input markets of interest (markets for pork and hogs, in our case) and enables the derivation of the impacts of abolishing vertical integration on the relevant prices and quantities and the welfare of the interest groups involved (i.e., consumers, packers/pork producers, and hog producers). Our study examines the economic impacts of the abolishment of vertical integration under all possible (and plausible) cases/reasons for vertical integration and states of nature/vertical relationships that can emerge after the removal of this form of vertical control.
Our analysis considers also the impact of abolishing vertical integration on non-integrated packers. Specifically, the study develops strategic and extensive game-theoretic models to examine how the impacts of abolishing vertical integration (determined by the analysis of the vertical market system) affect the equilibrium outcomes of the strategic interactions between integrated and non-integrated pork producers.
CAFIO-PRG Findings
Analytical results are consistent across the different scenarios and forms of strategic interactions between pork producers and indicate that the abolishment of vertical integration in the US pork sector will hurt pork consumers, integrated packers and the hog producers involved. The only beneficiaries of this policy/change will be the non-integrated pork producers. However, the gains of these non-integrated pork producers are less than the consumer, hog producer and integrated pork producer losses, resulting in net social welfare losses from this policy.
Dr. Konstantinos Giannakas, H.W. Eberhard Distinguished Professor & CAFIO-PRG Director (kgiannakas@unl.edu)
Based on Giannakas K. “Economic Impacts of Abolishing Vertical Integration in the US Pork Industry.” Working Paper 57, Department of Agricultural Economics, University of Nebraska-Lincoln. Available at https://digitalcommons.unl.edu/ageconworkpap/57.