Bilateral Monopoly, Successive Monopoly, and Vertical Integration

Fritz Machlup and Martha Taber’s 1960 journal article examines whether vertical integration increases output and lowers consumer prices, setting technological economies aside. Its central argument is conditional: integration can remove restrictions created by separate profit maximization, but negotiated coordination may achieve the same result without common ownership. Neither monopoly structure nor joint profit maximization alone establishes a sufficient case for merger.

The authors distinguish three mechanisms often combined in arguments for integration: independent output restriction by bilateral monopolists, progressively less elastic derived demand along successive monopolies, and cumulative profit margins under full-cost pricing. All can produce prices above those of an integrated monopolist, but their assumptions and institutional settings differ.

The historical discussion reconstructs the development of bilateral-monopoly theory and challenges analogies between complementary suppliers and firms dealing directly as buyer and seller. Complementary suppliers need not negotiate with one another; a sole seller and sole buyer necessarily transact. Models that treat their decisions as independent can therefore suppress the bargaining process that determines their conduct. An inherited formulation illustrates the resulting uncertainty:

There would then be no means of determining beforehand what amount of brass would be produced, nor therefore the price at which it could be sold.

The issue is not simply whether a unique equilibrium can be calculated. It is whether the assumed contracting procedure adequately represents the relationship. Price-only negotiation leaves quantities open, whereas a price-and-quantity agreement can determine output while leaving the division of joint profits subject to bargaining. The historical argument also exposes the incentive problem when a supplier cannot secure the returns from expanding downstream sales:

Under the conditions supposed, A could not count on reaping the whole, nor even any share at all of the benefit, from increased sales, that would be got by lowering the price of copper . . .

Machlup and Taber distinguish theories yielding determinate price and quantity, theories leaving both indeterminate, and theories establishing determinate output through negotiated quantity contracts. Their preferred explanation for ordinary bilateral monopoly allows separate firms to select the joint-profit-maximizing volume. Integration then need not change either output or the final consumer price; bargaining concerns the allocation of profits rather than an unavoidable loss from fragmentation.

This conclusion is not universal. Price-only bargaining remains relevant where organizations cannot commit to quantities. Trade unions, agricultural cooperatives, cartels, and bilateral oligopolies may negotiate prices without controlling employment, production, or purchases. In such circumstances, integration may relax output restrictions. The article’s methodological contribution is to connect the bargaining model to institutional capacities rather than apply a unilateral-monopoly pricing rule indiscriminately.

The analysis of successive monopoly turns to a different configuration: firms may monopolize their products while purchasing inputs competitively. Repeated revenue marginalization and cumulative mark-ups can then restrict final output. The argument under examination expresses the chain-wide effect as follows:

The final degree of reduction of product will depend upon the degree of monopoly in all preceding stages. These have to be aggregated so as to give the tendency to divergence from the social optimum in the whole series of the production stages of the product.

The authors nevertheless question how readily this result supports actual mergers. Successive monopolies without monopsony imply differences in firm scale that may make supplier–customer integration less plausible. Their criticism of Spengler also concerns the compatibility of matched production volumes with competitive input purchasing and the derivation of demand curves. Successive oligopoly may provide a more realistic setting for some claimed integration benefits.

The conclusion separates coordination from ownership and static pricing gains from future competition. Contracts can secure joint profit maximization without permanently consolidating firms. Merger may instead entrench monopoly, extend market power, facilitate discrimination, or restrict independent firms’ access to inputs. Limits on merger may encourage entry into neighboring production stages through new facilities. The article thus rejects a general policy inference from a conditional pricing result: eliminating successive restrictions within a fixed monopoly structure does not necessarily justify making that structure more durable.