Countervailing Power and Product Diversity

The emergence of powerful, big box retailers such as Wal-Mart and Home Depot has enhanced the interest among both academics and non-academics in the effects of countervailing power. One of the major concerns expressed by some commentators is that rising countervailing power will lead to poorer product selection for consumers. They believe that manufacturers of some product varieties will be forced to exit as their profit margins are squeezed by the power retailers. From the perspective of economic theory, however, it is not obvious that a retailer with countervailing power would have incentives to reduce the variety of products available to its customers. Indeed, so far there has been no formal analysis to determine whether such concern over product diversity is warranted. The existing theoretical analyses of countervailing power focus on the price effects, i.e., whether consumer prices will increase or decrease as a result of increased buyer power in the hands of retailers (von Ungern-Sternberg 1996, Dobson and Waterson 1997, Chen 2003). The objective of this paper is to analyse the effects of countervailing power on product diversity. In the model, product diversity is measured by the number of differentiated products sold by retailers in equilibrium. There are several retailers, but only one is large enough to possess countervailing power against the manufacturer(s). In the upstream market, I consider two scenarios. In the first scenario, there is a monopolist manufacturer who sets the number of product varieties to be produced. In the second scenario, products are supplied by monopolistically competitive firms, with each firm selling one variety. The focus of my analysis will be on how a rise in the large retailer's countervailing power, measured by its ability to capture a larger share of the joint profit, will affect the equilibrium number of varieties produced. References: Chen, Z. (2003) "Dominant retailers and the countervailing power hypothesis," RAND Journal of Economics, forthcoming Dobson, P.W. and M. Waterson.(1997) "Countervailing power and consumer prices," Economic Journal, 107: 418-430 von Ungern-Sternberg, T. (1996) "Countervailing power revisited," International Journal of Industrial Organization, 14:507-20