Vanderbilt Unive rsity 1 Effects of Upstream Horizontal Mergers: Does the Retail Sector Matter? Luke Froeb April 12, 2002 University of Florida
Dec 17, 2015
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Vertical Restraints & Effects of Upstream Horizontal Mergers:
Does the Retail Sector Matter?
Luke FroebApril 12, 2002
University of Florida
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Related work Pass Through rates and the Price
Effects of Mergers mba.vanderbilt.edu/luke.froeb/papers/
Coauthors, Steve Tschantz & Greg Werden Views are my own, do not purport to
represent those of my co-authors or Justice or FTC.
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Talk Outline Policy & Theory Background
I will go over fast unless I get questions 3 Games of retailer-manufacturer
behavior Empirical Example of a Chicago Bread
Merger in each Game Conclusions & Unanswered questions
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Background: Retail Sector is Consolidating in US In US, Wal-Mart, Kmart, Target, Costco,
and Sears—account for 60 percent of general-merchandise sales General-merchandise is 15 % of all retail sales
Productivity advantage over smaller retailers Economies of scale Economies of purchasing Economies of distribution
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Retail consolidation also in Europe
In EU, top 10 grocery stores forecast to increase share to 50-60% Currently at 38%
Wal-Mart entering Europe Also entering South America
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Policy Reaction to Retail Consolidation
FTC challenging some retail mergers Blocked Kroger + Winn-Dixie Blocked Staples + Office Depot
Competitive analysis based on increase in local (within-city) horizontal market power “standard” horizontal analysis
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Standard Horizontal Analysis: Benefit-Cost of Merger
Goal: quantitative estimate of merger effect. Necessary to weigh efficiencies
against loss of competition Two methodologies
Model-based simulations “Natural” experiments, e.g. Staples-
Office Depot
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Model-based simulation Model current competition Estimate model parameters Simulate loss of competition using
estimated parameters Merger effects modeled as difference
between pre- and post-merger Nash equilibria
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Model-based Simulation:Kroger + Winn Dixie
Estimate “Gravity” choice model Survey density
in Charlotte, NC
Dots represent grocery stores
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Empirical Comparisonse.g., Staples-Office Depot
Prices 6% higher in 1-superstore cities
15% pass through 40%=6%/.15
compensating MC reduction
big pass-through big merger effect,
Both depend on demand curvature
So estimate merger effects and pass-through rates together.
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Theory & Policy Towards Horizontal vs. Vertical restraints Horizontal
Widespread consensus on how to model horizontal restraints.
Collusion or “unilateral” effects Policy debate is empirical
Vertical No consensus on how to model vertical
restraints. Policy debate is theoretical
Or on “necessary conditions,” e.g., market-share screens
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Questioning the Consensus on Horizontal Restraints How do vertical restraints change
standard horizontal merger analysis which ignores retail sector? Focus of paper
How do vertical restraints affect our understanding of retail consolidation? Does standard horizontal analysis
suffice? Not going to answer this one.
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Methodology: put Monopoly Retail sector on top of Bertrand Manufacturing Oligopoly Strategic form bargaining game (n+1 players)
Upstream Bertrand oligopolists (n) make take-it-or-leave-it offers to retail monopolist (1)
Retailer chooses the best set of offers Pre-merger Nash equilibrium
Then, two upstream manufacturers merge Merger effect is difference between pre- and post-
merger equilibria What happens to retail prices and quantities?
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Results: the retail sector matters--a lot. Upstream horizontal mergers can
have a variety of effects when “filtered” through retail sector Transparent retail sector Opaque retail sector Double marginalization
Can amplify merger effects, or Attenuate them
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Three Different Games Game 1: retailer must carry all profitable
products Transparent retail sector
Game 2: retailer has option of exclusive dealing Opaque retail sector
Game 3: manufacturers limited to offering wholesale unit prices independent of quantity Double marginalization
Can amplify or attenuate merger effects
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Game 1: retailer must carry all profitable products
Retailer internalizes price
effects between products
Manufacturer Set w’ to
maximize profitability on own product
Wholesale price below marginal cost to induce Bertrand prices
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Game 1: continued Manufacturers set wholesale prices
below mc to induce Bertrand (non-cooperative) pricing at retail level
Collect all profit (rev.) with fixed fees
Pricing & Merger effects are same as would occur if Manufacturers sold directly to consumers.
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Game 2: Retailer has Option of Exclusive Dealing Retailer has four options
Exclusive dealing with Mfg. 1, total profit=T1 Exclusive dealing with Mfg. 2, total profit=T2 Joint dealing with Mfg. 1 and 2, total profit=TJ Neither, total profit =0
Mfg.’s make contingent offers to retailer using two-part prices O’Brien & Shaffer (1997) and Bernheim &
Whinston (1998). Equilibrium is “efficient” in that Mfg’s
transfer at mc, and retailer maximizes joint profitability
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Game 2: Continued Profit split: winner must outbid next best
alternative 1 is most valuable alternative: T1>max(T2,TJ)
1’s profit=T1 - T2;
2’s profit=0;
retailer’s profit=T2;
1 and 2 are substitutes: T1+T2 > TJ > max(T1,T2) 1’s profit=TJ - T2;
2’s profit=TJ - T1;
retailer’s profit=T1 + T2 - TJ
1 and 2 are complements: TJ > T1+T2 > max(T1,T2) retailer’s profit=0
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Game 2: continued Manufacturers set wholesale prices at
marginal cost Retailer maximizes total profit
Retailers paid their marginal contribution to total profit
Mergers do not change retail prices But do transfer profit from retailer to
merged manufacturers
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Game 3: Wholesale prices are independent of quantity
Retailer profit (same) internalizes price
effects between products
Manufacturers face derived demand, q*
Bertrand equilibrium with derived demand.
Wholesale margins are functions of elasticity of derived demand
Depends on pass-through rates from wholesale to retail
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Game 3: continued Prices “too high”—double
marginalization. Big wholesale margins
Derived demand is usually less elastic than retail demand because
Wholesale prices are lower (which makes percentage price changes bigger)
Pass-through rates can be less than one Merger effects can be higher or lower
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3 Retail Games Illustrated: White Pan Bread in Chicago
All calibrated to same prices, quantities, pre-merger elasticities (logit demand)
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Logit vs. AIDS Demand Pass through rates for logit (95%),
linear (near 50%) demand are less than one. Relatively inelastic derived demand
Pass through rates for AIDS (180%), Constant Elas (near 200%) demand are higher Relatively elastic derived demand
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Conclusions Retail sector matters a lot for
standard horizontal merger analysis Constant mark-up or percentage mark-up
usually assumed which is transparent case.
Not correct if “opaque” or “double marginalization”.
Empirical Identification of retail game Games have negative, zero, and positive
wholesale margins, respectively.
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Unanswered Questions How do retailer’s behave?
Sales agents compensated on revenue commission
Positive wholesale margins Complex nonlinear contracts with
promotional allowances, quantity discounts is two-part pricing a good metaphor?
What about the n X k case (n manufacturers, k retailers)? Retailers compete on selection, price,
convenience. Does opaque equilibrium hold for n X k case?