This paper studies the competitive effect of vertical integration between pharmaceutical drug producers and distributors in an auction setting. Exploiting data on 814 thousand public procurement auctions supplying 2.5 million drugs in Russia, I identify the causal effect of vertical integration on procurement prices. If a single firm produces a drug, vertical integration
increases prices by 11% via foreclosure. If there are from two to four drug producers, vertical integration increases prices by 13% via raising rivals costs (RRC). If many firms produce the drug, foreclosure and RRC effects are negligible, and price decreases by 1.7% after the vertical integration due to the cost asymmetry generated by the efficiency gain. To explain these empirical findings, I propose an auction model where bidders negotiate with upstream
input suppliers.