Does Vertical Integration Effect Market Power? Evidence from U.S. Food Manufacturing Industries

Journal of Agricultural and Applied Economics, Apr 2005 by Bhuyan, Sanjib

Advertising and capital requirement. To represent the difference in entry conditions across industries, two variables are introduced, namely advertising intensity (ADVT) and capital requirement (KINT). Each of these variables is a part of the strategic behavior that firms in an industry may adopt to compete, deter entry, raise entry barriers, increase profitability, and enhance market power (Martin 1993), i.e., these variables represent firm conduct. Regarding advertising, whereas it has the beneficial impact of providing some useful information to the buyer, it also raises rivals' costs of competition or entry or even deters entry because of advertising's inherent lag effects. An index of such an entry barrier is used here in terms of advertising intensity (ADVT) defined as the advertising-to-sales ratio.

In terms of capital requirement to enter a food industry, any industry that requires heavy capital investment will have fewer new and potential entrants because sunk costs are likely to be higher in such industries. The index of capital intensity is defined as the capital-to-sales ratio (KINT) and, in this study, is used to represent such capital requirements. Both ADVT and KINT are expected to create entry barriers in the food industry and, thereby, to help raise market power, i.e., these two variables are expected to have positive and significant relationships to market power.

Demand conditions. Demand conditions across industries vary. To measure the fluctuation of downstream demand for food manufacturers' output and to control for differences across industries in demand conditions, the shipment data of the food manufacturing industry for census years 1982, 1987, 1992, and 1997 were used to compute a coefficient of variation for each industry in the sample. This coefficient of variation (of industry demand) is a measure of relative dispersion, and it was used to represent the fluctuation in demand for the food industry's output (DEMFLUC). Although highly fluctuating demand can dampen the ability of food manufacturing firms to exert market power because of the uncertainty associated with such demand conditions, there was no a priori belief about the impact of demand fluctuations on market power in the U.S. food industries.

Import discipline. It is commonly argued in the literature that import competition can significantly lower domestic market power and improve market performance (Esposito and Esposito). Import competition, defined as the import-to-sales ratio (IMPORT) or the competition from foreign firms, was expected to have a negative and significant impact on the domestic market power of U.S. food manufacturers.

Finally, like its predecessors, this is an industry-level study and, therefore, is likely to have some aggregation bias. Following Davies and Morris, the hypothesis used here is that such aggregation bias would have negative regression coefficients. To correct for such potential bias, an aggregation bias variable (INTRA) is defined as the proportion of total industry sales that are accounted for by sales within the industry, e.g., the value of shipment in the meat packing industry (SIC 2011) that is accounted for by SIC 2011, as recorded in the national input-output tables.