Scand. J. of Economics 111(3), 527–546, 2009 DOI: 10.1111/j.1467-9442.2009.01575.x Indirect versus Direct Constraints in Markets with Vertical Integration Roman Inderst ∗ University of Frankfurt, DE-60323 Frankfurt, Germany inderst@finance.uni-frankfurt.de Tommaso Valletti Imperial College London, London SW7 2AZ, England t.valletti@imperial.ac.uk Abstract For an assessment of market power on the wholesale (or merchant) market in the presence of vertically integrated firms, we analyze the interaction of direct constraints, arising from competition on the wholesale market, and of indirect constraints, arising from substitution on the retail market. A vertically integrated firm that still participates in the merchant market exerts both direct and indirect constraints. We analyze the factors that determine the impor- tance of indirect constraints. We find that, in contrast to a common presumption, indirect constraints are sometimes more powerful than direct constraints. We furthermore analyze the incentives of integrated firms to still participate in the merchant market, provided that this is technologically feasible. Keywords: Market power; antitrust; merchant market JEL classification: D21; D43 I. Introduction This paper contributes to the assessment of market power on wholesale mar- kets in the presence of vertically integrated firms. Our analysis is motivated by several recent antitrust cases in Europe that all raised the issue of how to appropriately take into account the presence of both “direct constraints” from competition on the wholesale market and “indirect constraints” from substitution on the retail market. In an important recent ruling, the European Court of First Instance (CFI) overruled the decision to block the proposed merger of Schneider Electric SA and Legrand SA. 1 While Schneider and Legrand were not vertically integrated, other firms (such as ABB and Siemens) competed only through ∗ Roman Inderst is a Visiting Professor at the Imperial College London. 1 CFI Judgment of 22.10.2002 on case T-310/01: Schneider v. Commission (Application for the annulment of Commission Decision C(2001)3014 of 10.10.2001 on case COMP/ M.2283—Schneider–Legrand). In July 2007, the European Union’s second-highest court ruled that Schneider is entitled to compensation. C  The editors of the Scandinavian Journal of Economics 2009. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.