Vertical Bargaining and Retail Competition: What Drives Countervailing Power? Germain Gaudin (DICE, Heinrich Heine University) July 2nd, 2016 Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 1 / 23
Introduction Changes in retail concentration Entry, exit, mergers (without cost efficiencies): Predictable effects in single-layer industries: more firms leads to lower price, Not so clear in multi-layer industries: Input price and retail price? How does concentration in one market affect the entire supply chain? Countervailing buyer power: [N]ew restraints on private power did appear to replace competition. They were nurtured by the same process of concentration which impaired or destroyed competition. But they appeared not on the same side of the market but on the opposite side, not with competitors but with customers or suppliers. John Kenneth Galbraith (1952) Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 2 / 23
Introduction Countervailing buyer power Claim that greater retail concentration gives retailers more bargaining power and: leads to lower input prices; this is then passed-on to consumers and reduces retail prices. Important to competition authorities in merger control, but little theoretical evidence: Dobson & Waterson (EJ 1997) and Iozzi & Valletti (AEJ:Micro 2014) only study linear demand systems. Tyagi (MS 1999) only Cournot with tioli offers. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 3 / 23
Introduction This paper I analyze countervailing buyer power (CBP) when input price is linear and possibly negotiated, without specific assumption on the functional form of demand, without specific assumption on the conduct of retail competition. Approach: Derive equilibrium with linear input price w and retail quantity Q and then look at impact of n. Countervailing buyer power There is a countervailing buyer power effect when dw/dn > 0. Retail effects Greater concentration decreases the retail price when dq/dn < 0. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 4 / 23
Introduction Main findings With take-it-or-leave-it (tioli) offers: A necessary (and often sufficient) condition for a CBP effect is that the retail pass-through rate is increasing, This rate depends on demand curvature and retail conduct (demand system), The magnitude of this effect depends on the rate at which competition intensity decreases with greater concentration, A necessary (and often sufficient) condition for a CBP effect to benefit consumers is that the marginal revenue curve of the total market slopes up. With bilateral bargaining: Conditions for CBP are generally made more difficult as retailers have more bargaining power, Resp. for consumer effects. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 5 / 23
Introduction Outline Simple Cournot-tioli model General tioli model Nash-bargaining game Conclusion Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 6 / 23
Simple Cournot-tioli model Simple Cournot-tioli model Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 7 / 23
Simple Cournot-tioli model Model First stage: One manufacturer, which sets input price w to n symmetric retailers. Constant manufacturer marginal cost c. Second stage: Retailers compete à la Cournot (homogeneous products). Q denotes total market quantity and inverse demand is P(Q), with P (Q) < 0. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 8 / 23
Simple Cournot-tioli model Linear tariffs Linear tariffs widely used in practice: Book-retailing industry (Gilbert, JEP 2015), Cable TV (Crawford & Yurukoglu, AER 2012), Hospital-Insurer relations (Ho & Lee, 2015), Medical supplies (Grennan, AER 2013), (Formerly) regulated network industries (e.g., access pricing in telecoms)... Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 9 / 23
Simple Cournot-tioli model Equilibrium Second stage: In a symmetric equilibrium: R P + QP /n = w. SOC given by R P (1 + 1/n) + QP /n < 0. First stage: Manufacturer maximizes (w c)q = (R c)q. In equilibrium: R + QR = c and w c = QR. SOC given by 2R + QR < 0. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 10 / 23
Simple Cournot-tioli model Countervailing buyer power effects In equilibrium: R + QR = c and w c = QR. Total differentiating by n and rearranging gives: dw dn = Q 2 /n 2 2R + QR (P R P R ) = (QR ) 2 d 2 p n 2 (2 ξ) dw }{{} 2 >0 where dp/dw is the retail pass-through rate, ξ = QR /R (SOC: 2 ξ > 0). CBP Cournot-tioli There is a countervailing buyer power effect (i.e. dw/dn > 0) iff the retail pass-through is increasing. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 11 / 23
Simple Cournot-tioli model Intuition Suppose retailers merge at a given wholesale price Upward pricing pressure. What should the manufacturer do? If upward pricing pressure implies different dp/dw, it wants to adjust w. if d 2 p/dw 2 < 0: Higher eqm price implies lower eqm pass-through Can increase w with little effect on Q, if d 2 p/dw 2 = 0 (Bulow & Pfleiderer, JPE 1983): Do nothing. if d 2 p/dw 2 > 0: Higher price implies larger pass-through Loss in Q too large, should reduce w. Pass-through (its derivative) is the necessary and sufficient variable to capture CBP effects. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 12 / 23
Simple Cournot-tioli model Quantity effects Also: dq dn = Q/n 2 2R + QR (2P + QP ) QP = R n 2 (2 σ) (2 ξ) }{{} >0 where σ = QP /P is the demand curvature and 1 + n σ > 0 from SOC. Quantity effects Cournot-tioli Greater concentration lowers retail prices iff 2 σ < 0. Note that d 2 p/dw 2 > 0 ξ < σ, so CBP is indeed necessary to have dq/dn < 0 (i.e. ξ < 2 < σ). Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 13 / 23
General tioli model General tioli model Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 14 / 23
General tioli model General Model Conduct parameter θ [0, 1] as an index of competitiveness (0 Bertrand/perfect comp. vs. 1 monopoly), see Weyl & Fabinger (JPE 2013). Allows for several types of substitute, possibly differentiated product competition: θ = 1 + j i Q j p i / Q i p i = 1 AggDivRat Symmetric equilibrium: θ(q), and its derivative wrt quantity, θ/ Q typic. 0. (Assume = 0 for clarity of exposition.) Similar formula for quantity competition. Gives, e.g. in Cournot θ = 1/n. Their partial derivatives wrt n: θ/ n < 0 because total market size kept constant, Example: in Cournot θ/ n = 1/n 2, 2 θ/ n Q typically 0 (Assume = 0 for clarity). Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 15 / 23
General tioli model CBP and Quantity effects dw dn = (QR ) 2 2 ξ θ n } {{ } >0 d 2 p dw 2 dq dn = QP θ R (2 ξ) n }{{} >0 (2 σ) Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 16 / 23
Bargaining model Bargaining model Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 17 / 23
Bargaining model Nash-bargaining and manufacturer s disagreement point Axiomatic Nash-bargaining solution. Pairwise bilateral bargaining, Simultaneous bargaining, Over linear input price (and only over linear input price), A retailer s disagreement payoff is zero, Manufacturer s one depends on remaining retailers. Main problem: Outsiders purchased quantity is (i) implicitly given in manufacturer s disagreement payoff and (ii) implicitly given by the equilibrium equation. Solution: A set of (reasonable) assumptions such that they are the same, in and out of eqm. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 18 / 23
Bargaining model Timing 1 Manufacturer and retailer i bargain over w i, simultaneously i, sign contract, 2 Order and delivery: Retailer i orders q i units at unit price decided in 1, 3 Retailers observe (or not) their competitors negotiation breakdowns if any, 4 If breakdown, no contract renegotiation feasible without failing pair, 5 Retailers compete in price or quantity at the retail level. Result: Disagreement point is well behaved. Without these, only quantity competition with non-observable breakdowns tractable without a given functional form. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 19 / 23
Bargaining model CBP and Quantity effects d 2 p/dw 2 and slope of marketwide marginal revenue remain the main drivers of CBP and Quantity effects. New terms also appear in the formulas, and typically make it more difficult to observe CBP and Quantity effects as retailers have more bargaining power. Example: CBP effects under Cournot with β 1/2 dw dn = QR 2 R w/ Q }{{} >0 QΨ 2 R Z βn 2 } {{ } >0 d 2 p dw 2 + Ψ }{{} n. <0 Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 20 / 23
Literature and Conclusion Literature and Conclusion Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 21 / 23
Literature (Selected) Literature Extends and generalizes: Dobson & Waterson (EJ 1997), Tyagi (MS 1999), Iozzi & Valletti (AEJ:Micro 2014). Recent empirical lit. using Nash-bargaining over linear wholesale price: Retailing: Draganska, Klapper & Villas-Boas (MkS 2010), Cable TV: Crawford & Yurukoglu (AER 2012), Crawford et al. (2015), Health-care: Ho & Lee (2015), Gowrisankaran, Nevo & Town (AER 2015), Medical devices: Grennan (AER 2013, MS 2014). Other types of CBP: Same source, non-competing ret.: Inderst & Wey (EER 2007, JEEA 2011), Different source: Chen (RAND 2003), Christou & Papadopoulos (EL 2015), Also, asymmetries and waterbed effect: Inderst & Valletti (JIE 2011). Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 22 / 23
Conclusion Conclusion Contribution: CBP under general demand system, Economic intuition for CBP framed with pass-through rate, Characterization of eqm under Nash-in-Nash with general demand system. Results: Increasing retail pass-through rate necessary (can be suff.) for CBP effect, Increasing marketwide marginal revenue necessary (can be suff.) for Q effect, Retailers bargaining power makes CBP and quantity effects less likely. Extensions: This paper: Firms profits, Variable conduct, Upstream fringe, Other CBP, Forthcoming: Upstream oligopolistic competition. Germain Gaudin (DICE) Countervailing Power July 2nd, 2016 23 / 23