Economies of Scale, Product Composition, and Vertical Pricing in Food Retail

This paper examines whether the market dominance of large retail chains is driven by costbased economies of scale or by strategic differences in product assortment and pricing. While large retailers are commonly believed to achieve lower costs and charge lower prices due to scale advantages, observed price differences may also reflect differences in product composition. Using NielsenIQ Retail Scanner Data for the U.S. yogurt market, we combine a reduced-form analysis with a vertical structural model of manufacturer–retailer competition to jointly analyze prices, demand, and costs. We document a “price paradox”: large chains exhibit higher average prices but charge lower prices for identical products relative to smaller retailers. We show that this pattern is driven by a composition effect, as large retailers carry a greater share of premium, high-priced products. On the demand side, raw estimates suggest higher price elasticity at large chains, but this difference disappears after controlling for price levels and product characteristics, indicating similar consumer responsiveness across retailer types. On the supply side, the recovered marginal costs provide no evidence that large retailers enjoy a cost advantage. These findings suggest that the competitive advantage of large retailers arises primarily from strategic assortment and pricing decisions rather than from lower marginal costs. More broadly, the results highlight that price-based measures of competition may be misleading when product composition differs across firms, with implications for how market concentration and retail dominance are evaluated in policy.