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Journal of Economics and Finance

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01-01-2013

Information markets, product markets and vertical merger

Authors: Jihui Chen, Qihong Liu

Published in: Journal of Economics and Finance | Issue 1/2013

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Abstract

In many markets, firms have the option of advertising at price comparison sites to broaden their market reach. Such sites are often controlled by profit-maximizing “information gatekeepers” charging advertising fees. This paper considers vertical merger between such a monopoly information gatekeeper and a firm in the product market. We find that: (i) If the integrated firm can act as a price leader before independent firms make advertising and pricing decisions, then the merger is profitable. (ii) If the integrated firm cannot move first, then the merger is unprofitable, or divestiture is optimal in the case where the firm has already created the gatekeeper. As a result, the merged entity has an incentive to invest in technologies to support a price leader.

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For instance, a recent comScore monthly analysis reports that more than 35.7 million unique users visited CNET Networks site (i.e., Shopper.com) in November 2007 (source: “Retail sites see surge in traffic as holiday season kicks off,” http://www.comscore.com/press/release.asp?press=1974).

Source: “Group of magazine publishers is said to be building an online newsstand,” by Brian Stelter, November 25, 2009, New York Times (link: http://www.nytimes.com/2009/11/25/business/media/25mag.html?em= &pagewanted=print).

See, for instance, “Are all online travel sites good for the consumer: an examination of supplier-owned online travel sites.” Hearing before the subcommittee on commerce, trade, and consumer protection of the Committee on Energy and Commerce, House of Representatives One Hundred Seventh Congress, Second Session, July 18, 2002, serial no. 107-120.

Hereafter, the terms “the merged firm” refers to the firm in the product market that merges with the gatekeeper, “the independent firm” refers to any remaining firm in the product market, and “the merged entity” refers to the entity which consists of the gatekeeper and the merged firm.

Relationship between information gatekeeper and firms in the product market is different from that between typical upstream and downstream firms. For example, in the former, the gatekeeper allows independent firms to reach more customers, and the additional demand is generally contingent on the firms’ advertising decisions. In the latter, the upstream firm sells a product to a downstream firm, and the downstream demand is usually fixed. Because of these differences, existing studies on vertical integration cannot be directly applied to mergers between information markets and the product markets they serve.

A number of empirical studies examine the effect of price comparison sites on competition. For example, Brown and Goolsbee (2002) find that the growth of Internet price comparison sites enhances competition in the online term life insurance market significantly.

For an excellent and detailed discussion, see Chapter 17 Pepall et al. (2004).

Essentially the merger allows the monopolist to price discriminate between the integrated firm and others. Price discrimination is irrelevant in our model since all firms are identical. The gatekeeper earns the same profit when it chooses to foreclose all but one firm, regardless of its merger decision.

Most studies in the literature assume a monopoly information gatekeeper, except for Lin (2007), who considers competition among gatekeepers.

For example, in 2002, about 15% of the most popular wines were not available in McLean-area stores in VA. With the removal of legal barriers in 2005, Virginia residents obtained the access to out-of-state (online) retailers carrying a wider variety of wines (through online orders). In this sense, online wine listings has a demand-creating effect on McLean-area residents. Source: “Online competition brings down wine prices in local stores,” by Jeff Grabmeier (http://researchnews.osu.edu/archive/winesale.htm).

The existence of gatekeeper loyals makes foreclosure less profitable since the gatekeeper would not be able to recoup the lost sales from these consumers by any means.

We refer α = 0 to the case where the gatekeeper forecloses all but one firms. Note that the strategy in which no firm ever advertises (also α = 0) is never optimal, since the gatekeeper would earn zero profit.

Upon data availability, one can empirically test this claim.

Of course a higher price would also reduce the competition among non-advertising firms. However, it has no effect on the independent firm’s propensity to advertise, which depends solely on the incremental profit generated by advertising at the gatekeeper.

With asymmetric sizes of loyal consumers, the largest firms would charge the monopoly price (Baye et al. 1992; Kocas and Kiyak 2006). In the literature on information gatekeepers, Arnold et al. (forthcoming) specifically consider the case of asymmetric firms.

Technically, this is true only if 0 ≤ α < 1, when the alternative profit is π _i(r, NA). When α = 1, as we show in Section 3.1.1, firm’s alternative option is not to advertise and set p < r, earning a higher profit than π _i(r, NA).

In addition to convenience, all parties, both individual sellers and buyers, at Amazon.com also enjoy the mutual “trust” through the Amazon brand. Yang (2008) considers variable advertising fees which are proportional to sales in his model. In this paper, we restrict our analysis to fixed advertising fees.

For example, Buy.com adopts a similar model to Amazon’s by listing competitors’ prices next to its own.

When \(\phi \rightarrow \frac{\beta _{h}}{n}r^{+}\), α→1⁻ . However, when \(\phi =\frac{\beta _{h}}{n}r\), α is not equal to 1. ϕ has to further drop to φ _α = 1 for α = 1. There is a discontinuity in α when φ is in the vicinity of \(\frac{\beta _{h}}{n}r\).

Since firm m always advertises and sets price p _m, an independent firm would actually only mix prices in [·, p _m), i.e., does not include the upper bound p _m. To get a closed upper bound, we assume that if an independent firm sets price equal to p _m, it can beat firm m over consumers with low loyalty. Then independent firms mix prices in [·,p _m].

It can be easily shown that setting a sufficiently low p _m is less profitable than to set p _m = r.

Arnold M, Li C, Saliba C, Zhang L (2009) Asymmetric market shares, advertising, and pricing: equilibrium with an information gatekeeper. J Ind Econ (forthcoming)

Baye MR, Kovenock D, de Vries CG (1992) It takes two-to-tango: equilibria in a model of sales. Games Econom Behav 4(4):493–510CrossRef

Baye MR, Morgan J (2001) Information gatekeepers on the Internet and the competitiveness of homogeneous product markets. Am Econ Rev 91(3):454–474CrossRef

Baye MR, Morgan J (2002) Information gatekeepers and price discrimination on the Internet. Econ Lett 76(1):47–51CrossRef

Baye MR, Morgan J (2007) Brand and price advertising in online markets. Working paper

Brown J, Goolsbee A (2002) Does the Internet make markets more competitive? evidence from the life insurance industry. J Polit Econ 110(3):481–507CrossRef

Chen J (2008) Backward integrated information gatekeepers and independent divisions in the product market.The B.E. Journal of Theoretical Economics 8(1) (Topics), Article 7

Johnson E, Moe W, Fader P, Bellman S, Lohse G (2004) On the depth and dynamics of online search behavior. Manage Sci 50(3):299–308CrossRef

Kocas C, Kiyak T (2006) Theory and evidence on pricing by asymmetric oligopolies. Int J Ind Organ 24(1):83–105CrossRef

Lin Y (2007) Competing gatekeepers. The B.E. Journal of Theoretical Economics 7(1) (Topics), Article 30

Morgan J, Orzen H, Sefton M (2006) An experimental study of price dispersion. Games Econom Behav 54(1):134–158CrossRef

Pepall L, Richards D, Norman G (2004) Industrial organization: contemporary theory and practice (with economic applications), 3rd edn. South-Western College, Cincinnati

Wu R, Xue L, Whinston A (2005) Economic analysis of the supplier–reseller symbiotic competition in an online distribution business. Working paper

Yang G (2008) Firm heterogeneities, click-through fees and pricing in oligopoly: theory and evidence. PhD dissertation, Indiana University

Title: Information markets, product markets and vertical merger
Authors: Jihui Chen
Qihong Liu
Publication date: 01-01-2013
Publisher: Springer US
Published in: Journal of Economics and Finance / Issue 1/2013
Print ISSN: 1055-0925
Electronic ISSN: 1938-9744
DOI: https://doi.org/10.1007/s12197-010-9169-0

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