A strategic rationale for captive supplies

Partial backward integration is prevalent in many agricultural and natural resource processing industries. A strategic rationale for partial backward integration is developed for a dominant firm with a competitive fringe purc hasing from competitive input suppliers. A partially backward integrated do minant firm potentially can increase profit through production efficiency g ains and through a lower price for externally purchased input. The optimal degree of backward integration results when the dominant firm's profit from exerting monopsony market power in the external spot market equals its pro fit from producing raw input internally, less the incremental cost of acqui ring internal raw input production capacity. Comparative statics results ar e consistent with recent empirical studies of the beef packing industry.