Network industries such as telecommunications, electricity, gas, and rail contain both naturally monopolistic and potentially competitive sectors. Typically, firms in more competitive sectors need access to these monopolized sectors if they want to offer a full service.

A crucial policy issue in such industries is whether to allow vertical integration by an upstream monopolist into more competitive downstream sectors. It has been alleged that allowing vertical integration has benefits of reducing transactions costs, realizing technological economies, and eliminating successive markups. on the other hand, vertical integration may cause access discrimination by the vertically integrated firm against its rivals in the downstream markets.

This paper examines the incentive of a vertically integrated firm to raise the cost of access it provides to its downstream rival. I show that the integrated firm may or may not have an incentive to raise its downstream rival's costs through access discrimination. When the downstream products are poor substitutes, the integrated firm has no incentive to raise the rival's costs while it does have such an incentive when the products are close substitutes. I also show that, when the integrated firm has a larger downstream market share or the regulated wholesale price charged by the upstream firm is closer to the marginal cost, the integrated firm is more likely to engage in access discrimination. These results are robust whether the firms compete in linear prices or in two-part tariffs.