Can vertical integration by a monopsonist harm consumer welfare?

Vertical integration by a monopsonist is generally believed not to harm consumers. This paper demonstrates, in a natural economic setting, that this conventional wisdom may not hold. We model one-on-one bargaining between a monopsonist and independent suppliers when the set of suppliers cannot be expanded easily ex post and show that a vertically separated monopolist is vulnerable to holdup. Without integration, we demonstrate that a bottleneck monopsonist has an incentive to encourage more upstream entry than would arise in a pure neoclassical monopoly. Having more suppliers mitigates the holdup power of any one. This, however, distorts the cost structure of the industry toward greater industry output and, hence, lowers final good prices. Vertical integration mitigates the hold-up Problem faced by the monopsonist. It allows it to generate and appropriate a greater level of industry profits, at the expense of consumers. (C) 2004 Elsevier B.V. All rights reserved.