Vertical Integration and Market Power in Supply Networks

Problem definition: Vertical integration, a strategic approach where firms control multiple stages of production and distribution, offers potential operational efficiencies and market power. Although the operations management (OM) literature has emphasized its benefits for supply chain coordination and cost savings, antitrust studies raise concerns about how vertical mergers may enable dominant firms to limit competition by creating entry barriers and harming consumer welfare. Despite extensive theoretical debate, empirical evidence on the postintegration effects of vertical mergers—particularly from an OM perspective—remains limited. This paper aims to bridge this gap by examining how vertical integration affects both market competition and operational outcomes. Methodology/results: Following recent advances in empirical industrial organization, we estimate firms’ markups using production function estimations. We compile a novel data set on vertical integration cases using the FactSet Revere and SDC platinum databases, identifying 213 vertical mergers between firms with existing buyer-supplier relationships from 2003 to 2022. We employ a staggered difference-in-difference approach combined with instrumental variables (constructed using mutual fund stock outflow events) that create exogenous variation in firms’ decisions to integrate vertically. Our analysis reveals that vertical integration increased acquiring firms’ markups by 13% and their rivals’ markups by 6%, on average. More importantly, we disentangle these markup increases and show that, although integration firms achieve cost efficiencies (2.9% cost reduction), the rivals experience a statistically significant 2% increase in costs. The raising of rival costs provides evidence that increased markups drive market prices higher which in turn harms customers. Managerial implications: Vertical integration reshapes firms’ operational cost structures and influences the competitive dynamics within supply chains. Our findings show that integrating firms achieve meaningful cost reductions, consistent with improved coordination and tighter control over procurement. At the same time, rival firms experience higher costs, likely due to restricted access to key inputs or diminished bargaining power—an effect that can weaken their operational flexibility and competitive position. This reallocation of cost advantages suggests that integration does not only optimize internal processes but also imposes operational pressure on competitors. Managers evaluating vertical integration should account for these strategic externalities: Although integration can unlock efficiencies and improve supply reliability, it also alters industry cost dynamics and may provoke regulatory scrutiny if perceived to undermine competition. For regulators, the evidence highlights the need to assess not just price effects, but also changes in cost structures and supply network configurations when evaluating the broader consequences of vertical mergers.

Supplemental Material: The online appendices are available at https://doi.org/10.1287/msom.2024.1454.