ELGL columnist Graham Sheridan returns to discuss vertical integration and its ever-changing definition.
The Changing State of Vertical Integration
by Graham Sheridan, June 11, 2014
In American history, laws against vertical integration have been passed to protect local jobs and promote market competitiveness. However, in the last few months, a few different cases have come up in which state and local governments have seen their economic development efforts bump up against vertical integration laws. Striking the proper balance can promote competitiveness and bring jobs to your area. The most high profile case of this so far has been Tesla Motors being denied two stores in New Jersey. The craft beer industry has also run into this law in the South.
First, what is vertical integration? It is where one company controls all aspects of a product from production to sale. For example, if De Beers owns diamond mines, makes rings, and sells them in a De Beers store, their operation would be vertically integrated – controlling all aspects of the production of their product. In the past, regulators have seen vertical integration as a step on the road to monopoly.
In the case of cars, most states have laws requiring locally owned dealerships sell cars. This is why you cannot go to a Ford Store or GMC Store, but instead must go to a dealer to buy a car. Those who oppose this say it adds a middleman, causing a price increase for the consumer. Those who favor say that, with only a few car makers, the monopolies would have pricing power, and having many different dealerships adds competition where there would be less. Auto-making newcomer Tesla Motors ran into the locally owned dealership law in this year when they attempted to open a showroom in the Garden State. The law preventing vertical integration tipped the Christie Administration’s hand and the showrooms were shut down. The state legislature is now trying to find a loophole that protects local dealers and allows the Tesla showroom.
In South Carolina, the same question has come up concerning alcoholic beverages. Brewers are not allowed to open their own bars, except for on-site brewpubs. For example, you cannot go to an Anheuser-Busch bar or Jack Daniel’s in your hometown, but can get a sample at the brewery. However, the craft beer movement has been calling this law into question. Until recently, for example, if the same person owns a brewpub and a second restaurant, she cannot sell her own beer in the second restaurant (this is becoming an ever more common situation, as local restaurant chains get into brewing). A brewpub may want to open a second bar without setting up a second brewing operation. South Carolina, though, just changed the law to be more lenient about this.
However, is the law obsolete in the Internet age? Many companies are allowed to open their own showrooms and stores. For example, is Apple opening Apple stores really different from Ford opening a Ford store? How much more competitive is the PC market than the phone, laptop, and tablet market? Are cars really different?
Supplemental Reading
It’s Not a Mall World After All by Graham Sheridan