Vertical relationships between manufacturers and retailers

This study consists of five parts. The first one focuses on testing different models of vertical contracting between manufacturers and retailers in the supermarket industry. I first estimate demand and use the estimates to compute price-cost margins for retailers and manufacturers under different supply models without observing wholesale prices. I then test which set of margins seems to be compatible with the margins obtained from direct estimates of cost and select the best among the non-nested competing models. The models considered are: (1) a double marginalization pricing model; (2) a vertically integrated model; and (3) a variety of alternative (strategic) supply scenarios, allowing for collusion, non-linear pricing and strategic behavior with respect to private label products. Using data on yogurt sold at several stores in a large urban area of the United States, I find that wholesale prices are close to marginal cost and that retailers have pricing power in the vertical chain. This is consistent with non-linear pricing by the manufacturers or with high bargaining power of the retailers. The second part provides requirements for identification of these different models of vertical contracting. Identification of the degree of market power in homogeneous and differentiated product industries has been the focus of several studies. Most of this work assumes that manufacturers have the pricing decisions and don't model explicitly retailers' pricing decisions. Here I model oligopolistic pricing behavior both in the manufacturer and in the retail markets and provide the requirements for identification of the vertical models even if there is no wholesale price data available. The non-nested testing procedure is described in detail in the third part. The fourth part extends the demand model while assuming that retailers have pricing power in the vertical chain and that there are zero manufacturer margins. In particular, I present an alternative model of demand for multiple categories allowing explicitly for cross-category externalities. This is an interesting extension since, typically, consumers purchase a basket of products from different retail categories on a given shopping trip. The misspecification of modeling consumer demand for a single category without considering multiple category purchases results in incorrect measures of consumer responses to retail marketing activities. Furthermore, when using those demand estimates to answer questions regarding retail market power this can lead to misleading conclusions. Finally, in the fifth part I present some extensions and future empirical work on vertical contracts.