Structural Analysis of Manufacturer Pricing in the Presence of a Strategic Retailer
Consumer goods manufacturers usually sell their brands to consumers through common independent retailers. Theoretical research on such channel structures has analyzed the optimal behavior of channel members under alternative assumptions of manufacturer-retailer interaction (Vertical Strategic Interaction). Research in Empirical Industrial Organization has focused on analyzing the competitive interactions between manufacturers (Horizontal Strategic Interaction). Decision support systems have made various assumptions about retailer-pricing rules (e.g., constant markup, category-profit-maximization). The appropriateness of such assumptions about strategic behavior for any specific market, however, is an empirical question. This paper therefore empirically infers (1) the Vertical Strategic Interaction (VSI) between manufacturers and retailer, (2) the Horizontal Strategic Interaction (HSI) between manufacturers simultaneously with the VSI, and (3) the pricing rule used by a retailer. The approach is particularly appealing because it can be used with widely available scanner data, where there is no information on wholesale prices. Researchers usually have no access to wholesale prices. Even manufacturers, who have access to their own wholesale prices, usually have limited information on competitors' wholesale prices. In the absence of wholesale prices, we derive formulae for wholesale prices using game-theoretic solution techniques under the specific assumptions of vertical and horizontal strategic interaction and retailer-pricing rules. We then embed the formulae for wholesale prices into the estimation equations. While our empirical illustration is using scanner data without wholesale prices, the model itself can be applied when wholesale prices are available. Early research on the inference of HSI among manufacturers in setting wholesale prices using scanner data (e.g., Kadiyali et al. 1996, 1999) made the simplifying assumption that retailers charge a constant margin. This assumption enabled them to infer wholesale prices and analyze competitive interactions between manufacturers. In this paper, we show that this model is econometrically identical to a model that measures retail-price coordination across brands. Hence, the inferred cooperation among manufacturers could be exaggerated by the coordinated pricing (category management) done by the retailer. We find empirical support for this argument. This highlights the need to properly model and infer VSI simultaneously to accurately estimate the HSI when using data at the retail level. Functional forms of demand have been evaluated in terms of the fit of the model to sales data. But recent theoretical research on channels (Lee and Staelin 1997, Tyagi 1999) has shown that the functional form has serious implications for strategic behavior such as retail passthrough. While the logit and linear model implies equilibrium passthrough of less than 100% (Lee and Staelin call this Vertical Strategic Substitute (VSS)), the multiplicative model implies optimal passthrough of greater than 100% (Vertical Strategic Complement (VSC)). Because passthrough rates on promotions have been found to be below or above 100% (Chevalier and Curhan 1976, Armstrong 1991), we empirically test the appropriateness of the logit (VSS) and the multiplicative (VSC) functional form for the data. We perform our analysis in the yogurt and peanut butter categories for the two biggest stores in a local market. We found that the VSS implications of the logit fit the data better than the multiplicative model. We also find that for both categories, the best-fitting model is one in which (1) the retailer maximizes category profits, (2) the VSI is Manufacturer-Stackelberg, and (3) manufacturer pricing (HSI) is tacitly collusive. The fact that the retailer maximizes category profits is consistent with theoretical expectations. The inference that the VSI is Manufacturer-Stackelberg reflects the institutional reality of the timing of the game. Retailers set their retail prices after manufacturers set their wholesale prices. Note that in the stores and product categories that we analyze, the two manufacturers own the dominant brands with combined market shares of about 82% in the yogurt market and 65% in the peanut butter market. The result is also consistent with a balance of power argument in the literature. The finding that manufacturer pricing is tacitly collusive is consistent with the argument that firms involved in long-term competition in concentrated markets can achieve tacit collusion. Managers use decision support systems for promotion planning that routinely make assumptions about VSI, HSI, and the functional form. The results from our analysis are of substantive import in judging the appropriateness of assumptions made in such decision support systems.
Volume (Year): 20 (2001)
Issue (Month): 3 (October)
|Contact details of provider:|| Postal: 7240 Parkway Drive, Suite 300, Hanover, MD 21076 USA|
Web page: http://www.informs.org/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Greg M. Allenby, 1989. "A Unified Approach to Identifying, Estimating and Testing Demand Structures with Aggregate Scanner Data," Marketing Science, INFORMS, vol. 8(3), pages 265-280.
- Timothy W. McGuire & Richard Staelin, 1983. "An Industry Equilibrium Analysis of Downstream Vertical Integration," Marketing Science, INFORMS, vol. 2(2), pages 161-191.
- Peter M. Guadagni & John D. C. Little, 1983. "A Logit Model of Brand Choice Calibrated on Scanner Data," Marketing Science, INFORMS, vol. 2(3), pages 203-238.
- David Besanko & Sachin Gupta & Dipak Jain, 1998. "Logit Demand Estimation Under Competitive Pricing Behavior: An Equilibrium Framework," Management Science, INFORMS, vol. 44(11-Part-1), pages 1533-1547, November.
- J. Miguel Villas-Boas & Russell S. Winer, 1999. "Endogeneity in Brand Choice Models," Management Science, INFORMS, vol. 45(10), pages 1324-1338, October.
- Jorge M. Silva-Risso & Randolph E. Bucklin & Donald G. Morrison, 1999. "A Decision Support System for Planning Manufacturers' Sales Promotion Calendars," Marketing Science, INFORMS, vol. 18(3), pages 274-300.
- David F. Midgley & Robert E. Marks & Lee C. Cooper, 1997.
"Breeding Competitive Strategies,"
INFORMS, vol. 43(3), pages 257-275, March.
- Nevo, Aviv, 1998.
"Measuring Market Power in the Ready-To-Eat Cereal Industry,"
Food Marketing Policy Center Research Reports
037, University of Connecticut, Department of Agricultural and Resource Economics, Charles J. Zwick Center for Food and Resource Policy.
- Nevo, Aviv, 2001. "Measuring Market Power in the Ready-to-Eat Cereal Industry," Econometrica, Econometric Society, vol. 69(2), pages 307-42, March.
- Aviv Nevo, 1998. "Measuring Market Power in the Ready-to-Eat Cereal Industry," NBER Working Papers 6387, National Bureau of Economic Research, Inc.
- Nevo, Aviv, 1999. "Measuring Market Power in the Ready-to-Eat Cereal Industry," Competition Policy Center, Working Paper Series qt7cm5p858, Competition Policy Center, Institute for Business and Economic Research, UC Berkeley.
- Nevo, Aviv, 1998. "Measuring Market Power in the Ready-To-Eat Cereal Industry," Research Reports 25164, University of Connecticut, Food Marketing Policy Center.
- Aviv Nevo, 2003. "Measuring Market Power in the Ready-to-Eat Cereal Industry," Microeconomics 0303006, EconWPA.
- Eunkyu Lee & Richard Staelin, 1997. "Vertical Strategic Interaction: Implications for Channel Pricing Strategy," Marketing Science, INFORMS, vol. 16(3), pages 185-207.
- Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057 Elsevier.
- Abhik Roy & Dominique M. Hanssens & Jagmohan S. Raju, 1994. "Competitive Pricing by a Price Leader," Management Science, INFORMS, vol. 40(7), pages 809-823, July.
- David R. Bell & James M. Lattin, 1998. "Shopping Behavior and Consumer Preference for Store Price Format: Why “Large Basket” Shoppers Prefer EDLP," Marketing Science, INFORMS, vol. 17(1), pages 66-88.
- Gerard J. Tellis & Fred S. Zufryden, 1995. "Tackling the Retailer Decision Maze: Which Brands to Discount, How Much, When and Why?," Marketing Science, INFORMS, vol. 14(3), pages 271-299.
- William Boulding & Richard Staelin, 1995. "Identifying Generalizable Effects of Strategic Actions on Firm Performance: The Case of Demand-Side Returns to R&D Spending," Marketing Science, INFORMS, vol. 14(3_supplem), pages G222-G236.
- Deepak Agrawal, 1996. "Effect of Brand Loyalty on Advertising and Trade Promotions: A Game Theoretic Analysis with Empirical Evidence," Marketing Science, INFORMS, vol. 15(1), pages 86-108.
- Randolph E. Bucklin & Sunil Gupta, 1999. "Commercial Use of UPC Scanner Data: Industry and Academic Perspectives," Marketing Science, INFORMS, vol. 18(3), pages 247-273.
- Scott A. Neslin & Stephen G. Powell & Linda Schneider Stone, 1995. "The Effects of Retailer and Consumer Response on Optimal Manufacturer Advertising and Trade Promotion Strategies," Management Science, INFORMS, vol. 41(5), pages 749-766, May.
- Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-90, July.
- Ronald W. Cotterill & William P. Putsis Jr. & Ravi Dhar, 1999.
"Assessing the Competitive Interaction Between Private Labels and National Brands,"
Food Marketing Policy Center Research Reports
044, University of Connecticut, Department of Agricultural and Resource Economics, Charles J. Zwick Center for Food and Resource Policy.
- Cotterill, Ronald W & Putsis, William P, Jr & Dhar, Ravi, 2000. "Assessing the Competitive Interaction between Private Labels and National Brands," The Journal of Business, University of Chicago Press, vol. 73(1), pages 109-37, January.
- Cotterill, Ronald W. & Putsis, William P., Jr. & Dhar, Ravi, 1999. "Assessing the Competitive Interaction Between Private Labels and National Brands," Research Reports 25177, University of Connecticut, Food Marketing Policy Center.
- William P. Putsis Jr. & Ronald W. Cotterill & Ravi Dhar, 1999. "Assessing the Competitive Interaction between Private Labels and National Brands," Yale School of Management Working Papers ysm131, Yale School of Management.
- S. Chan Choi, 1991. "Price Competition in a Channel Structure with a Common Retailer," Marketing Science, INFORMS, vol. 10(4), pages 271-296.
- Vuong, Quang H, 1989. "Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses," Econometrica, Econometric Society, vol. 57(2), pages 307-33, March.
- Vrinda Kadiyali, 1996. "Entry, Its Deterrence, and Its Accommodation: A Study of the U.S. Photographic Film Industry," RAND Journal of Economics, The RAND Corporation, vol. 27(3), pages 452-478, Autumn.
- Dan Horsky & Paul Nelson, 1992. "New Brand Positioning and Pricing in an Oligopolistic Market," Marketing Science, INFORMS, vol. 11(2), pages 133-153.
When requesting a correction, please mention this item's handle: RePEc:inm:ormksc:v:20:y:2001:i:3:p:244-264. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mirko Janc)
If references are entirely missing, you can add them using this form.