The economic rationale for vertical integration in the tech sector

Hardware devices to software to services: Strategic risk-taking, innovation and investments in the pursuit of efficiency and consumer value.

Vertical integration is a relatively widespread practice across the economy – both in “digital” and “traditional” sectors. With the advent of digital transformation, many firms across industries, irrespective of their size or market prominence, attempt to add software and/or services to their products or develop partnerships to ensure a coordinated approach to deliver the best end user experience. When a firm chooses to invest and enter a market served by its suppliers (upward, i.e. backward integration) or in its output/customers’ markets (downward i.e. forward integration), it is delivering additional competition to the economy, a clear pro-competitive effect.

Different companies and value chains have different implications for competition analysis. As is demonstrated in the theory and practice of competition economics, vertical integration strategies are associated not just with harm to competition but also with efficiency and consumer benefits. In fact, these positive aspects are routinely considered and evaluated by competition and regulatory authorities in cases involving markets and regulatory design. Ex-post evaluations have found a degree of support for vertical mergers and acquisitions to be favourable in terms of their market and consumer outcomes due to these efficiencies. Nevertheless, in competition enforcement, the merits of the facts and effects of conduct have to be considered in a case by case assessment.

In summary, vertical integration cannot be reduced to select catchwords or theoretical concerns – it is valuable to study it in practice. It is a broader phenomenon of significant importance to value creation and consumer welfare outcomes in present-day free-market economies. The aim of this study is to shed light on the economic rationale of vertical integration. This is a key aspect defining the business models of some digital players. In turn, this is relevant to important policy conversations on the case for and effects of regulation of various aspects associated with the operation of vertically integrated businesses.

Based on the review of the economic literature, as well as the appraisal of major business developments in tech and the wider economy, of key case studies and of competition authority practice, this study finds:

On efficiencies

 On incentives

 On regulation

In conclusion, policy makers would benefit from taking, as a starting point, the well-established economic evidence on benefits and drivers of vertical integration, while taking a case-by-case approach to regulatory design, balancing demonstrable efficiencies and concerns.

The study is commissioned by Apple.