The International Consortium on Agricultural Biotechnology Research (ICABR)
Backward Integration by Seed Companies and Gene Owner Control Issues in Biotechnology
Jill J. McCluskey,
Thomas I. Wahl,
Washington State University,
Reasons to vertically integrate include gaining access to markets, lowering transaction costs, extending market power, and avoiding being a victim of market power. If a seed company invests in a biotech lab rather than pay biotech companies to insert the genes, then the seed company is engaging in upstream vertical integration. Why would a seed company want to do this? The first reason is to avoid being a victim of market power and, as a result, reduce the cost of developing bioengineered products by taking advantage of economies of scale. If the biotech company charges a fixed rate to insert genes and the seed company wants to offer bioengineered products on a regular basis, it could be less expensive for the seed company to do it themselves. Alternatively, the seed company may be able to enter into a long-term contractual relationship with the biotech company that results in quantity discounts. Note, that these arrangements can be equivalent to vertically integrating.
The gene owner is a monopolistic supplier of that particular gene. If the gene is an essential input to a particular product (that is, the product cannot be produced without the use of that gene), then the monopolistic supplier can extract profits from the producing industry. This can be done by charging a high price for the gene or with technology fees. Depending on the production process, it may pay for the gene owner to integrate forward to extend monopoly power to the seed industry. If the production process is a fixed proportions type of production process (that is, the inputs are always used in the same proportions, regardless of the relative factor prices), then the upstream monopoly does not have an incentive to vertically integrate. It makes the same profit whether it integrates or not. The monopolistic supplier can control the final price consumers pay without vertically integrating because the downstream firm cannot substitute away from the input produced by the monopoly.
The previous argument depends on the assumption that the gene owner is a monopolistic supplier. If the market becomes saturated with biotech products, so that there are many close substitutes, then the gene owner will not be able to extract profits in the form of technology fees. The current market is not saturated, and it is uncertain when market saturation will occur. For some genes, scientists may never find a close substitute.
The key question is under what circumstances should a seed company engage in backwards vertical integration? We use a simple industrial organization model to analyze the vertical integration issues by production process.