Vertical Integration

Vertical integration takes place when different aspects of production in the same line of business are integrated in a single company. For example, a company which combines manufacturing and distribution of a product is engaging in vertical integration.

Vertical integrated companies can often operate more efficiently due to improved information flow among the various production levels, lower transaction costs, and better coordination. Vertical integration can also benefit from economies of scale that lead to lower costs and greater efficiency.

Companies that are vertically integrated can often manipulate market power they possess at one level of production to increase their market share at "upstream" or "downstream" aspects of business. An example of this is the situation which led to the 1912 United States v. Terminal Railroad Association case. The case is described in a March 10, 1997 speech by Federal Trade Commission chairman Robert Pitofsky:

A group of 14 railroads owned the Terminal Railroad Association of St. Louis. The association controlled, through acquisitions, the two bridges and one ferry service that could be used to transport railcars across the Mississippi River at St. Louis. The river ran between St. Louis and East St. Louis, so railroads had to use bridges or ferries to get across the river, and terminal facilities were needed to connect individual railroads to the bridges and ferry facilities. One peculiarity of the situation was that none of the 24 railroads that served St Louis had a line that passed all the way through. All of them had a terminus on one side of the river or the other, so interconnection facilities were essential to serve both St. Louis and East St. Louis, and points beyond. Thus, none of the railroads could transport railcars across the river without using the association's facilities.

By charging exporbitant prices to non-member railroads who wished to use the association's transportation facilities, the members of the association sought to use their monopoly power over terminal facilties to increase their market share in the related railroad freight business. Because the terminal facilities were essential for railroads seeking to ship products between points east of the Mississippi and points west, non-member railroads were put at a severe competitive disadvantage.