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Vertical Channel Analysis of the U.S. Milk Market

  • Hovhannisyan, Vardges
  • Stiegert, Kyle W.

The objective of the research in this study is to evaluate the pricing and market conduct of milk manufacturers and retailers. Using data from a U.S. Midwestern state, we estimate a random coefficient logit demand model (RCL) to empirically investigate a range of possible scenarios in the milk supply chain. These include vertical leader-follower model with underlying Bertrand-Nash pricing, models allowing for nonlinear pricing contracts, and collusion scenarios at various levels in the supply chain. This study contributes to the literature in the following ways. First, it generalizes the RCL demand model via Box-Cox power transformation. While previous studies rely on ad hoc specified linear indirect utility, this procedure allows data to determine the functional form of utility. Power transformation parameters cannot be obtained analytically with product-level data, given that consumer choices are unobserved. We propose an algorithm to estimate the transformation and consumer heterogeneous taste parameters sequentially. The model is identified using annual variation in consumer demographics along with cross-sectional and time series variation in milk consumption. Finally, the milk choice set is allowed to vary across markets. It should be mentioned that jointly estimating the manufacturing sector, the vertical channel, and the retail sector will more likely yield reliable estimates of structural parameters vis-à-vis studies investigating food supply chain sectors in isolation. Several key results are obtained from the research. First, the estimate of demand “superelasticity”suggests that retailers have incentives to adjust retail markups to enhance their market power. Next, supply selection bias associated with imposing restriction on the demand-side framework is shown to have formidable policy implications. Namely, empirical results from the general demand show that retailers are more powerful than they would appear otherwise. In the face of high concentration and a small presence of Wall-Mart in these markets this seems a plausible scenario.

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Paper provided by Agricultural and Applied Economics Association in its series 2011 Annual Meeting, July 24-26, 2011, Pittsburgh, Pennsylvania with number 103631.

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Date of creation: 2011
Date of revision:
Handle: RePEc:ags:aaea11:103631
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  1. Kenneth Train, 2003. "Discrete Choice Methods with Simulation," Online economics textbooks, SUNY-Oswego, Department of Economics, number emetr2, March.
  2. Elena Lopez & Rigoberto A. Lopez, 2008. "Demand for Differentiated Milk Products: Implications for Price Competition," Food Marketing Policy Center Research Reports 104, University of Connecticut, Department of Agricultural and Resource Economics, Charles J. Zwick Center for Food and Resource Policy.
  3. Celine, Bonnet & Dubois, Pierre & Villas-Boas, Sofia B., 2009. "Empirical Evidence on the Role of Non Linear Wholesale Pricing and Vertical Restraints on Cost Pass-Through," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt5nq6h34n, Department of Agricultural & Resource Economics, UC Berkeley.
  4. Gasmi, Farid & Laffont, Jean-Jacques & Vuong, Quang, 1992. "Econometric Analysis of Collusive Behavior in a Soft Drink Market," IDEI Working Papers 16, Institut d'Économie Industrielle (IDEI), Toulouse.
  5. Emi Nakamura & Dawit Zerom, 2009. "Accounting for Incomplete Pass-Through," NBER Working Papers 15255, National Bureau of Economic Research, Inc.
  6. Aviv Nevo, 2000. "A Practitioner's Guide to Estimation of Random-Coefficients Logit Models of Demand," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 9(4), pages 513-548, December.
  7. Richards, Timothy J. & Allender, William J. & Pofahl, Geoffrey M., 2010. "Commodity Price Pass-Through in Differentiated Retail Food Markets," 2010 Annual Meeting, July 25-27, 2010, Denver, Colorado 61187, Agricultural and Applied Economics Association.
  8. Fabian Bergès-Sennou, 2006. "Store loyalty, bargaining power and the private label production issue," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 33(3), pages 315-335, September.
  9. Hyde, Charles Evan & Perloff, Jeffrey M., 1996. "Multimarket Market Power Estimation: The Australian Retail Meat Sector," 1997 Conference (41st), January 22-24, 1997, Gold Coast, Australia 136227, Australian Agricultural and Resource Economics Society.
  10. Bonnet, Céline & Dubois, Pierre, 2009. "Inference on Vertical Contracts between Manufacturers and Retailers Allowing for Nonlinear Pricing and Resale Price Maintenance," IDEI Working Papers 583, Institut d'Économie Industrielle (IDEI), Toulouse.
  11. K. Sudhir & Vrinda Kadiyali & Vithala R. Rao, 2001. "Structural Analysis of Manufacturer Pricing in the Presence of a Strategic Retailer," Yale School of Management Working Papers ysm229, Yale School of Management.
  12. Deaton, Angus S & Muellbauer, John, 1980. "An Almost Ideal Demand System," American Economic Review, American Economic Association, vol. 70(3), pages 312-26, June.
  13. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-90, July.
  14. Pradeep K. Chintagunta & André Bonfrer & Inseong Song, 2002. "Investigating the Effects of Store-Brand Introduction on Retailer Demand and Pricing Behavior," Management Science, INFORMS, vol. 48(10), pages 1242-1267, October.
  15. Villas-Boas, Sofia B., 2007. "Vertical relationships between manufacturers and retailers: inference with limited data," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt6gz1t778, Department of Agricultural & Resource Economics, UC Berkeley.
  16. K. Sudhir, 2001. "Structural Analysis of Manufacturer Pricing in the Presence of a Strategic Retailer," Marketing Science, INFORMS, vol. 20(3), pages 244-264, October.
  17. Smith, Richard J, 1992. "Non-nested.Tests for Competing Models Estimated by Generalized Method of Moments," Econometrica, Econometric Society, vol. 60(4), pages 973-80, July.
  18. Douglas Rivers & Quang Vuong, 2002. "Model selection tests for nonlinear dynamic models," Econometrics Journal, Royal Economic Society, vol. 5(1), pages 1-39, June.
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