Profit-enhancing competitive pressure in vertically related industries

Under a simple Cournot model with vertical relations, when downstream firms engage in process R&D, the profits of input suppliers for which upstream competition exists may be larger than those in which each input supplier has a bilateral monopoly relation with its buyer (downstream firm). This is because upstream competition leads to higher levels of investment by the downstream firms. Furthermore, we incorporate the decisions of downstream firms to acquire the ability to procure input from potential outside suppliers, which has the effect of placing competitive pressure on existing input suppliers. We show that no downstream firm acquires such an ability to procure its input from potential outside suppliers in some cases although the acquisition could benefit the input suppliers.

► Downstream firms engage in process R&D.
► Upstream competition leads to higher levels of investment by the downstream firms.
► Upstream competition may enhance the profits of upstream firms.
► Those downstream firms may prefer exclusive relations rather than upstream competition.