The International Consortium on Agricultural Biotechnology Research (ICABR)

Non technical abstract

 Vertical Integration in Biotechnology: Efficiency and Reputation Issues 

Jill J. McCluskey and Thomas I. Wahl

Opportunities in biotech include increasing quality through cost reduction and value adding innovations.  Although the cost of investment in biotech research is large, so is the potential payoff in terms of premiums.  A lot attention has been paid to the fact that life science companies rapidly consolidated and vertically integrated by acquiring seed companies.  Less attention has been paid to backwards integration, such as food or seed companies that have invested in biotech labs rather than pay biotech companies to insert the genes.  First, using industrial organization arguments about inefficiencies created by market power, this paper discussed efficiency reasons for vertical integration.

There are efficiency explanations for the increased vertical integration.  The first possible inefficiency results from restricted output caused by market power at both the upstream and downstream levels.  If there is market power in both the upstream firm (the life science company) and the downstream firm (the seed company)—which is likely the case for these industries—then because of the double markup problem, it will be beneficial for the two firms to vertically integrate.

Secondly, we discuss production processes and efficiency. 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 bioengineered product cannot be produced without the use of that gene), then the monopolistic supplier can extract profits from the producing industry.  Depending on the production process, it may pay for the gene owner to integrate forward to extend monopoly power to the seed industry.

A second and perhaps more interesting reason for vertical integration is the complementarity between biotech research and reputation.  As with any complicated business decision, there are tradeoffs for a seed company to integrate backwards by investing in a biotech laboratory and staff.  One major advantage to an in-house biotech facility is increased brand name goodwill due to maintaining the public image of being high quality and staying on the cutting edge.  A particular niche product seed company may be currently perceived as being the technology leader and having a high-end product.  Positive brand-name perception allows this company to demand high margins.  If this seed company does not become a leader in biotechnology and its competitors do, then public perception of the company’s brand will likely be adversely affected.  In other words, the company in question will no longer be perceived as "cutting edge."  Therefore, investment in biotech research may be necessary in order to maintain high margins.  It is a signal to consumers that the seed company is a technology leader.  In sum, there are complementarities that come from offering both the best brand/product reputation and the best genetics.

This paper presented a model of reputation, in which investment in a biotech lab affects quality perceptions. In the model, the marginal revenue from reputation must equal the cost of changing perceptions of quality from investment in a biotech lab.  Although the minimum investment to start a biotech lab is large, it will be profitable in terms of brand name reputation for some firms.  In order to maintain the status of the industry leader and preserve high margins, certain seed companies should integrate backwards by engaging in their own biotech research.

Home Page Non tecnical Abstract 2001 Program Registration Hotel accommodation Ravello and surroundings Social program