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

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

Because forward vertical integration (FVI) may have competitive as well as anticompetitive effects in a market, there is no a priori knowledge of which of these two effects dominate in U.S. food manufacturing industries. Results in Table 2 show that neither effect was prominent in the U.S. food industries during the study period. Although the direction of the relationship supports a positive impact of forward vertical integration on market power, the estimated coefficient was not statistically significant. This may be due to the very low level of forward vertical integration in the U.S. food industries or may be due to the extremely low degree of association between market power and forward vertical integration (correlation coefficient is 0.041, Appendix Table 2). Whereas some previous studies (e.g., Martin 1994, p. 308) found that increased vertical integration led to increased oligopolistic coordination and market power, this study was unable to find such a link between vertical integration and market power in the U.S. food industries. Thus, the results of this study do not support the hypothesis that forward vertical integration significantly impacts (either positively or negatively) market power in the U.S. food industries.

In terms of the impact of market concentration on the food industry's market power, results in Table 2 show that market power would increase if an industry is concentrated either at the national level (CR4) or at the local or regional levels (REG). These findings support the a priori reasoning presented earlier and lend support to previous studies that showed that higher concentration will enhance market power (e.g., Martin 1993; Scherer and Ross; Rogers). In terms of the impact of industry conduct on industry market power, study results show that advertising (ADVT) had a positive and significant impact on market power as expected. Past studies have shown similar evidence on the impact of advertising on market power (Martin 1993, Chapter 16). This implies that advertising (or product differentiation) may have created entry barriers by raising rivals' costs of competition or entry. That is not surprising because there is ample evidence in the literature that advertising raises barriers to entry and has an adverse effect on competition (Shepherd and Shepherd, p. 265). Thus, high market concentration and higher advertising in the food industries would lead to increased market power, and consequently would have a detrimental effeet on allocative efficiency in the food industries.

Capital intensity (KINT) had a significantly negative impact on market power and did not support the a priori causality reasoning. Noting that the variable KlNT was one of the variables used to represent strategic behavior that firms in an industry can adopt to deter entry in an effort to enhance their market power (Martin 1993), it can be argued that food manufacturing firms in the study period were unable to create entry barriers (the correlation coefficient between market power and capital intensity is negative and extremely low, approximately - 0.04, Appendix Table 2). A similar argument was made by Bhuyan that food manufacturing firms were unable to erect effective entry barriers using capital as a strategic variable.