VERTICAL INTEGRATION IN THE INTERNET INDUSTRY

Pınar DOĞAN (Koç University)

This paper studies competition in the Internet industry with a stylized two layered network structure, and examines incentives for vertical integration between an upstream backbone provider and a downstream Internet Service Provider (ISP). The downstream competition for supplying Internet access is considered within a geographical area between two horizontally differentiated ISPs. In the upstream market, two interconnected backbones with asymmetric installed bases compete for ISPs to provide connectivity to the backbone network. It is shown for this setting that the larger backbone has an incentive to integrate with one of the ISPs if the installed base difference between the backbones is relatively small. When vertical integration occurs, the large backbone increases the price of connectivity, and puts the non-integrated rival to a disadvantage. No vertical integration is observed between the small backbone and any of the ISPs.