Essays in Industrial Organization: The Effects of Vertical Integration on Prices and New Product Introduction (2024)

This dissertation consists of three essays that study the effects of vertical integration in the field of industrial organization. The first chapter studies the effects of vertical integration on the vertically integrated company, specifically, the effects on prices and new product introduction. The second chapter studies the effects of vertical integration on the vertically integrated company's competitor. The third chapter studies the effects of vertical integration on the new product introduction in detail, and discusses the important policy implications.

In the first chapter, I study the effects of vertical integration on the vertically integrated company, specifically, the effects on prices and new product introduction. Upstream and downstream companies both charge markups, and separated production generally incurs higher cost. Different incentives of upstream and downstream companies and high negotiation costs may impede new product introduction process. Vertical integration solves these problems. This chapter studies empirically the effects of vertical integration: whether it leads to a price decrease, which comes from synergy and the elimination of double marginalization; and whether it leads to more new products introduced to market, because it eases the new product introduction process. Specifically, this chapter studies the 2010 vertical integrations of the two largest soda companies, The Coca-Cola Company and PepsiCo, with their largest downstream bottlers, respectively, by using bottlers’ territory maps together with prices and sales data. In this chapter, all carbonated soft drink master brands of The Coca-Cola Company and PepsiCo are included in the analysis. Results show that the vertical integrations lead to 0.3%-0.6% price decrease for products of The Coca-Cola Company and 1.4%-1.6% price decrease for products of PepsiCo; and they lead to more new products introduced to vertically integrated markets: annually 9%-10% more new products for The Coca-Cola Company, and 5%-8% more new products for PepsiCo.

In the second chapter, I study the effects of vertical integration on the vertically integrated company's competitor, specifically, the effects on prices and new product introduction. The vertically integrated bottlers (Coca-Cola Enterprises, Pepsi Bottling Group and Pepsi Americas) bottled Dr Pepper's products both before and after the vertical integration. For Dr Pepper Snapple Group, its competitors, The Coca-Cola Company and PepsiCo, controlled its downstream bottlers after the vertical integrations. In the soda industry, the bottlers set the price of final products. Furthermore, if the upstream company wants to introduce a new product, it needs to negotiate with downstream bottlers for them to bottle and distribute the products. After the vertical integration, The Coca-Cola Company and PepsiCo have incentives to increase the price of the Dr Pepper's products so that consumers will substitute from Dr Pepper's products to Coca-Cola's and Pepsi Cola's products. Furthermore, when Dr Pepper wants to introduce a new product, The Coca-Cola Company and PepsiCo may impede this process, leading to fewer new products from Dr Pepper, which will be beneficial for The Coca-Cola Company and PepsiCo. Empirically, only products of three master brands, Coca-Cola, Pepsi Cola and Dr Pepper, are included in the analysis. Results show that the vertical integrations lead to 0.7%-1.0% price decrease for products of Coca-Cola, 1.4%-2.2% price decrease for products of Pepsi Cola, and 0.3%-0.7% price increase for products of Dr Pepper. For the new product introduction, vertical integrations lead to more new products for the vertically integrated company and fewer new products for the vertically integrated company's competitor: annually 12%-13% more new products of Coca-Cola, 10%-12% more new products of Pepsi Cola, and 9%-15% fewer new products of Dr Pepper.

In the third chapter, I study more about these new products and about how vertical integration affects new product introduction process. Products are defined using six characteristics. For each new product, I find out what is the new characteristics of this product. For all the new products introduced before vertical integration, I draw the distribution of these new characteristics, and I do the same for all new products introduced after vertical integration. I then study how vertical integration affects the distribution of new characteristics. For the new products of the vertically integrated company, after vertical integration, the distribution of new characteristics shifts from less innovative characteristics to more innovative characteristics. That is to say, the new products introduced after vertical integration are more innovative. For the new products of the vertically integrated company's competitor, after vertical integration, the distribution of new characteristics shifts from more innovative characteristics to less innovative characteristics. That is to say, the new products introduced after vertical integration are less innovative.

I also discuss the important policy implications in the third chapter. The effect of vertical integration on new product introduction has not drawn much attention in vertical merger reviews and evaluations. The results of this research show that the effect of vertical integration on new product introduction should be emphasized in anti-trust policies and their enforcement. This policy implication is very important, especially when many recent high-profile merger cases are vertical integrations, such as the AT&T and Time Warner merger, etc. And the recent development of anti-trust policies echoes the results of this research.