The efficiency of competing vertical chains with network externalities

This paper compares vertical integration and vertical separation with network externalities. Contrary to conventional wisdom, if network effects are stronger than the threshold level of the network externality parameter, manufacturers' strategic choices of wholesale prices move in opposite directions (i.e., wholesale prices may be strategic substitutes under Bertrand competition). Second, if the strength of network effects is strong enough, both profits and outputs are larger under vertical separation than under integration. Finally, if network effects are strong (weak), outputs (wholesale prices, retail prices), consumer surplus, and social welfare are higher (lower) under separation than integration.