DP3011 | Divisionalization in Vertical Structures

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We study the incentives to firms to create divisions once the vertical structure of an industry is taken into account. Downstream firms, those that must buy an essential input from upstream firms, may create divisions. Divisionalization reduces their bargaining power against upstream firms. This effect must be weighted against the usual incentive to divisionalize, namely the increase in the share of the final market that a firm obtains through the process. We show that incentives to divisionalize are severely reduced when compared with the standard results, and even that sometimes firms choose not to divisionalize at all. This Paper also shows the implications of the former analysis on the internal organization of firms and on the incentives to vertically integrate.