On the Timing of Vertical Relationships

Richard Ruble, Bruno Versaevel and Etienne Billette de Villemeur

No 627, IDEI Working Papers from Institut d'Économie Industrielle (IDEI), Toulouse

Abstract: We show that the standard analysis of vertical relationships transposes directly to investment timing. Thus, when a firm undertaking a project requires an outside supplier (e.g. an equipment manufacturer) to provide it with a discrete input, and if the supplier has market power, investment occurs too late from an industry standpoint. The distortion in firm decisions is characterized by a Lerner index, which is related to the parameters of a stochastic downstream demand. When feasible, vertical restraints restore efficiency. For instance, the upstream firm can induce entry at the correct investment threshold by selling a call option on the input. Otherwise, competition may substitute for vertical restraints. In particular, if two firms are engaged in a preemption race downstream, the upstream firm sells the input to the first investor at a discount that is chosen in such a way that the race to preempt exactly offsets the vertical externality, and this leader invests at the optimal market threshold.

JEL-codes: C73 D43 D92 L13 (search for similar items in EconPapers)
Date: 2010-06, Revised 2011-04-11
New Economics Papers: this item is included in nep-com
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Related works:
Working Paper: On the timing of vertical relationships (2011)
Working Paper: On the timing of vertical relationships (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:ide:wpaper:22883

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