Abstract :A key question in strategy research on exit relates to the competitive effects of vertical integration. Foreclosure and efficiency theory both predict that vertical integration by one firm can increase the exit rate of non-integrated rivals, but offer competing predictions for the cause of this increase. A related question relates to the effect of upstream markets for technology on downstream firm exit rates – i.e., to what extent does a thick upstream market for key technological inputs reduce foreclosure and reduce efficiency benefits of integration? This paper contributes to the literatures associated with these questions.
After developing a series of predictions for the effect of vertical integration patterns and upstream markets for technology on downstream exit rates, we test these predictions empirically with unusually detailed data on the U.S. laser printer and laser engine industries between 1984 and 1996. Of all the components within a laser printer, the laser engine is both the most expensive and subject to the most variation in governance. Roughly 25% of laser printer firms make at least some of their engines in-house, and roughly 70% of laser engine producers sell at least some of their engines to other firms. We exploit the variation in governance of engine procurement among printer firms to explore the effects of vertical integration on entry, exit, and pricing dynamics. We explore the effect of vertical integration and prevalence of laser engine suppliers on laser printer firm entry into industry segments (and the industry overall), exit from industry segments (and the industry overall), and pricing dynamics within each segment. We find evidence that increases in the engine supplier base is associated with reduced exit rates of printer firms, that increases in the number of vertically integrated rival printer firms is associated with increased exit rates, and that vertically integrated printer firms appear to drive down prices within their segment. These results are more consistent with efficiency than with foreclosure. We also find suggestive evidence that vertically integrated firms undertake systemic innovation more rapidly than their non-integrated rivals.