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Testing the Theory: Vertical Strategic Interaction and Demand Functional Form

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  • Ronald W. Cotterill
  • William P. Putsis Jr.

Abstract

Formulating theoretical models inevitably requires various simplifications that assist in making analysis tractable and that facilitate deriving closed form solutions. While the strategic insights gained from theoretical models of market phenomena are often quite valuable, testing the theoretical assumptions made in these models can aid in assessing the broader applicability of the conclusions drawn. This is particularly true in the channels area, where the focus of research to date has largely been theoretical in nature. In an initial attempt to examine some of the assumptions made in previous theoretical research (e.g., Jeuland and Shugan 1983, McGuire and Staelin 1983, Choi 1991, Raju, Sethuraman and Dhar 1995), we focus on a limited set of issues. First, we empirically examine the vertical channel assumptions made in two well-cited models of retailer-manufacturer interaction: a) the Choi (1991) Manufacturer-Stackelberg (MS) model, and b) the Raju, Sethuraman and Dhar (1995) Stackelberg model addressing store brands. Specifically, empirical tests are developed for Manufacturer Stackelberg conduct and the use of proportional mark-up rules within the channel. Second, since each of these models assume relatively simple linear demand structures, we examine how well linear demands characterize actual market behavior by comparing them to a flexible non-linear form, the LA/AIDS model. The empirical analysis is conducted using data for six individual categories (milk, butter, bread, pasta, margarine and instant coffee) across 59 local markets in 1991 and 1992. The empirical results generally support the assumptions of proportional mark-up behavior by retailers and Manufacturer Stackelberg conduct (Choi 1991) within the channel. While this lends support to the assumptions made in a number of theoretical models addressing channel behavior, we reject linear demands in a favor of a more flexible non-linear form. When combined with the analytical work of Lee and Staelin (1997), this suggests that additional theoretical and empirical work is needed in order to fully understand the implications of using a linear demand specification.

Suggested Citation

  • Ronald W. Cotterill & William P. Putsis Jr., 1998. "Testing the Theory: Vertical Strategic Interaction and Demand Functional Form," Food Marketing Policy Center Research Reports 040, University of Connecticut, Department of Agricultural and Resource Economics, Charles J. Zwick Center for Food and Resource Policy.
  • Handle: RePEc:zwi:fpcrep:040
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    File URL: http://fmpc.uconn.edu/publications/rr/rr40.pdf
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    References listed on IDEAS

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    1. S. Chan Choi, 1991. "Price Competition in a Channel Structure with a Common Retailer," Marketing Science, INFORMS, vol. 10(4), pages 271-296.
    2. Davidson, Russell & MacKinnon, James G, 1981. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Econometrica, Econometric Society, vol. 49(3), pages 781-793, May.
    3. Kadiyali, Vrinda & Vilcassim, Naufel & Chintagunta, Pradeep, 1998. "Product line extensions and competitive market interactions: An empirical analysis," Journal of Econometrics, Elsevier, vol. 89(1-2), pages 339-363, November.
    4. Timothy W. McGuire & Richard Staelin, 1983. "An Industry Equilibrium Analysis of Downstream Vertical Integration," Marketing Science, INFORMS, vol. 2(2), pages 161-191.
    5. Slade, Margaret E, 1995. "Product Rivalry with Multiple Strategic Weapons: An Analysis of Price and Advertising Competition," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(3), pages 445-476, Fall.
    6. Eunkyu Lee & Richard Staelin, 1997. "Vertical Strategic Interaction: Implications for Channel Pricing Strategy," Marketing Science, INFORMS, vol. 16(3), pages 185-207.
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    Citations

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    Cited by:

    1. 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 109-137, January.
    2. Du, Ying & Stiegert, Kyle W., 2009. "Strategic Vertical Pricing in the U.S. Butter Market," 2009 Annual Meeting, July 26-28, 2009, Milwaukee, Wisconsin 51712, Agricultural and Applied Economics Association.
    3. Vickner, Steven S. & Davies, Stephen P. & Fulton, Joan R. & Vantreese, Valerie L., 2000. "Estimating Market Power And Pricing Conduct For Private-Label And National Brands In A Product-Differentiated Oligopoly: The Case Of A Frozen Vegetable Market," Journal of Food Distribution Research, Food Distribution Research Society, vol. 31(02), July.
    4. Goddard, Ellen W. & Shank, Benjamin & Panter, Chris & Nilsson, Tomas K.H. & Cash, Sean B., 2007. "Canadian Chicken Industry: Consumer Preferences, Industry Structure and Producer Benefits from Investment in Research and Advertising," Project Report Series 52088, University of Alberta, Department of Resource Economics and Environmental Sociology.
    5. Putsis, William P., Jr., 1998. "Empirical Analysis of Competitive Interaction in Food Product Categories," Research Reports 25221, University of Connecticut, Food Marketing Policy Center.

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