Vertical Integration under Competition: Forward, Backward, or No Integration?
Article first published online: 16 MAY 2013
© 2013 Production and Operations Management Society
Production and Operations Management
Volume 23, Issue 1, pages 19–35, January 2014
How to Cite
Lin, Y.-T., Parlaktürk, A. K. and Swaminathan, J. M. (2014), Vertical Integration under Competition: Forward, Backward, or No Integration?. Production and Operations Management, 23: 19–35. doi: 10.1111/poms.12030
- Issue published online: 22 JAN 2014
- Article first published online: 16 MAY 2013
- Manuscript Accepted: NOV 2012
- Manuscript Received: DEC 2011
- vertical integration;
- supply chain;
We consider two competing supply chains, each consisting of supplier, a manufacturer, and a retailer. The suppliers exert effort to improve product quality, and the retailers sell products competitively. Each manufacturer chooses one of the three strategies: forward integration, backward integration, or no vertical integration. We seek for a subgame perfect Nash equilibrium and study the resulting market structure. Moreover, we characterize the effect of vertical integration on profitability, product price, and quality in a competitive setting. Existing literature has shown that, when manufacturers consider only forward integration, they may choose not to vertically integrate in equilibrium. In contrast, we find that, when both forward and backward integration options are considered, disintegration cannot be an equilibrium outcome. In this case, both manufacturers either forward or backward integrate, and the degree of product perishability, cost of quality, and how much consumers value quality are critical for the chosen direction of integration. Furthermore, competition increases attractiveness of backward integration relative to forward integration. We show that, while integrating backward unilaterally is always beneficial, unilateral forward integration can harm a manufacturer's profitability. Finally, vertical integration can result in a better quality product sold at a lower price.