Local Buyer Market Power and Horizontally Differentiated Manufacturers

In this paper we study a farmer-processor relationship, where market power is bidirectional: processors have buyer as well as seller market power. Farmers supply a homogeneous raw input to the processors, which, in turn, process it into a horizontally differentiated product. The analysis shows that the spread between prices that both parties receive can be decomposed into two components: one due to buyer market power in the agricultural input market and one due to seller market power in the differentiated processed market. Farmers receive a decreasing dollar share of the final price as concentration in the processed good market increases. On the other hand, the price spread due to processors' buyer (seller) market power decreases (increases) when farmers' transportation costs shrink and when consumers' strength for brand preference increases. We also examine welfare: while the surplus of farmers serving a specific processor is adversely affected in a more concentrated processed good market, the total surplus of farmers serving all processors is independent of the industry concentration. In addition, consumers are worse off when the processed good market is more concentrated and farmers' transportation costs are larger. While stronger brand preference implies a larger "travel cost" for consumers, it may encourage more processors to join the market and provide more varieties.