Vertical Mergers and Input Foreclosure When Rivals Can Substitute Inputs : Safe Harbor for Low Share of Input Sales to Rivals?

A vertical merger between a firm and an input supplier to that firm can generate efficiencies by eliminating double marginalization or alleviating other contracting inefficiencies. However, when the supplier also sells to that firm's rivals, a key antitrust concern is input foreclosure: the merged firm might raise prices of its input to rivals in order to increase its profit from output sales. A plausible intuition is that foreclosure risk is low when rivals can substitute (imperfectly) the merging supplier's input with other inputs and the share of their total input costs accounted for by that input (“cost share”) is low. We show this intuition can fail. While a low cost share may reduce the merged firm's ability to foreclose, it also magnifies the foreclosure incentive because the merged firm cannot extract much revenue from input sales to rivals and, hence, the cost of foreclosing rivals is low. We present a non-contrived analytic example where foreclosure occurs only if the merging supplier's cost share is low rather than high. In a subset of foreclosure cases, consumers are harmed and in a smaller subset, total welfare—consumer welfare plus industry profits—also declines. By contrast, for intermediate or high cost shares, the merger increases total welfare and consumer welfare: the beneficial effect of eliminating double marginalization outweighs any harmful effect from raising rivals' costs. In the example, therefore, a safe harbor for mergers where the merging supplier's cost share is sufficiently low would work in the wrong direction: foreclosure concerns are strongest when this share is low