Economic Impact of Vertical Coordination: A Multi-stage, Multi-player Analysis Under Alternative Market Structures

Increased coordination along the production-marketing chain has considerably changed the structure, conduct and performance of the industries as well as the organization of the marketing system (Manchester, 1997; MacDonald et al, 2000). Such changes have economic implications in terms of prices, output and welfare at each stage along the production-marketing chain. From a policy point of view it is important that we evaluate the welfare impact of vertical coordination or examine whether or not the expected cost-savings are realized or how consumer welfare is affected by supply contracts. A two-stage model of meat-packers' oligopsony power over the fed cattle marketers was studied by Koontz and Garcia (1997). Their study shows that producers received low price during collusive phase of meat packers than the non-collusive phase. Suominen (1992) analyzed the effects of vertical integration in a two-stage vertical setting for the pulp and paper industries in Finland and found that exogenous shocks have dissimilar effects on outputs and prices depending on the vertical integration pattern of an oligopolistic industry. Royer and Bhuyan (1995) studied the impact of vertical integration in a three-stage production-marketing setting with special focus on the interactions among farmer-owned cooperatives, assemblers and the processors. They found that cooperatives might have an incentive to integrate forward to capture value-added profits in the processed product market only when they could restrict member output. Most of these studies, however, do not explicitly model to measure the economic impact of vertical coordination in an imperfect market with multiple players or participants. In addition, most of the existing studies do not examine the welfare implications of alternative vertical coordination mechanisms at various stages for all participants at a given stage (e.g., contracts). This study contributes to the literature by modeling and testing 5 three-stage multi-player vertical coordination models that explicitly incorporate supply contract (partial and full), integration (partial and full), and market exchange mechanisms. It also models various interactions among players at each stage, among players at different stages, and the price, output and welfare impact of such strategic behavior. Study results show that regardless of the type of vertical coordination mechanism in place, the welfare of market participants, including consumers, was minimized when the firms at various stages of the production-marketing chain moved away from Cournot behavior towards collusion. In addition, increased collusion among participants at various stages under any given vertical coordination mechanism decreased total welfare, particularly those of farmers and consumers. Each market participants' profits were also found to be determined by the market power one possesses. In terms of policy implications, the study provides more insight into the welfare impact of alternative vertical coordination mechanisms in a multi-staged production-marketing chain when it involves multi-player interactions in an imperfect market. From a business perspective, this study shows how firms (in the food industry or otherwise, i.e., the models presented here are very flexible and replicable) at any stage along a vertical production-marketing chain may develop market/business strategies and how such strategies may impact suppliers, buyers, and consumers.