Vertical Integration and Rent Extraction: Lessons from the Dairy Industry

Farm cooperatives are often vertically integrated with dominant downstream firms and face very limited competition. We study a recent case of the dairy industry in New Zealand and find that the cooperative Fonterra adopts a price squeeze strategy in order to exploit its smaller competitors. We show that a price squeeze is a necessary condition for exploitation, not a practice of exclusion, and that the cooperative earns more than the monopoly profit through rent extraction. A price squeeze hurts the competitor and forecloses part of its efficient production, however, such foreclosure is a by-product of exploitation rather than as a result of intentional exclusion. We find that the current regulations in the New Zealand dairy industry cannot prevent the cooperative from exploiting its rivals. We further study the optimal regulation and structural remedy and provide testable implications for competition policy.