CARLETON ECONOMIC PAPERS

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1 CE 5-06 Dotream Competitio ad the Effect of Buyer oer Zhii Che Hog Dig Zhiyag Liu Carleto Uiverity Deloitte Eterprie Coultig July 05 Shaghai Uiverity of Fiace ad Ecoomic CARLETON ECONOMC AERS Departmet of Ecoomic 5 Coloel By Drive Ottaa, Otario, Caada KS 5B6

2 Dotream Competitio ad the Effect of Buyer oer By Zhii Che, Hog Dig, ad Zhiyag Liu* July 6, 05 Abtract To examie the iteractio betee buyer poer ad competitio iteity i a dotream market, e coider four variatio of a model i hich oligopolitic retailer compete i the dotream market ad oe of them i a large retailer that ha it o excluive upplier. We demotrate that a icreae i the buyer poer of the large retailer agait it upplier lead to a fall i retail price ad a improvemet i coumer elfare, ad thi i true eve i the extreme cae here the large retailer i a moopoly i the dotream market. More iteretigly, e fid that the beeficial effect of a icreae i buyer poer are large he the iteity of dotream competitio i lo, ith the effect beig the larget i the cae of dotream moopoly. JEL Claificatio: L, L4 * Che: Departmet of Ecoomic, Carleto Uiverity, Ottaa, Caada, zhii.che@carleto.ca; Dig: Chia Reearch ad ight Ceter, Deloitte Eterprie Coultig, Shaghai, Chia, adig@deloitte.com.c; Liu: School of teratioal Buie Admiitratio, Shaghai Uiverity of Fiace ad Ecoomic, Shaghai, Chia, zhiyag63@63.com. For commet e thak Gamal Atallah, Roe Ae Devli, Ca Erutku, atrick Rey, Aidya Se, Roger Ware, Larry White, the participat at the 0 EARE coferece ad to aoymou referee. Fiacial aitace from the Social Sciece ad Humaitie Reearch Coucil of Caada i gratefully ackoledged.

3 . troductio creaed cocetratio i the retail idutry ad the tremedou ucce of giat retailer, uch a Wal-Mart, Carrefour ad Teco, ha raied aaree ad cocer regardig the impact of retailer buyer poer i may coutrie. Thi ha led to a groig literature that aalyze the effect of buyer poer o coumer price ad ocial elfare. They iclude vo Uger- Sterberg 996, Dobo ad Watero 997, Che 003, Erutku 005, Smith ad Thaaouli 009, Mill 00, ad dert ad Valletti 0. A ill be elaborated o i ectio, a otable fidig from thi literature i that the preece of competitio i the dotream retail market i eceary for buyer poer to beefit coumer ad improve elfare. What i le clear, hoever, i ho the elfare coeuece of buyer poer are affected by chage i the iteity of retail competitio. For example, i it the cae that buyer poer i more beeficial to coumer he retail competitio i more itee? The aer to uch a uetio ill be of great aitace to competitio authoritie charged ith aeig the effect of riig buyer poer Che 007. thi regard, oe particularly relevat iue i ho a competitio authority hould deal ith cae here a merger betee to retailer or a coduct by a large retailer doe ot icreae the cocetratio of retailer market but ehace the buyer poer of the retailer. Thi iue may arie i a ituatio here to mergig retailer ell i differet geographic market. 3 Eve i a cae here the mergig retailer have overlap i ome geographic market, For example, the OECD held three roudtable to examie the impact of buyer poer o competitio OECD 998, 004 ad 008. Alo of ome relevace to the preet paper are the aalye of the log term impact of buyer poer o iovatio, product uality ad productio capacity Battigalli et al. 007, Motez 007, dert ad Wey 007 ad 0, Che For example, the coolidatio i Europea retail market ivolved a igificat umber of cro-border merger dert ad Shaffer 007 p45. particular, Wal-Mart etered everal EU coutrie via a trig of acuiitio, icludig that of Ada UK ad Wertkauf Germay.

4 a competitio authority typically ould either reject the merger or reuire divetiture by the mergig retailer i thoe local market here pot-merger cocetratio i deemed too high. 4 What thi mea i that, i practice, buyer poer become a iue i competitio aalyi oly after the cocer over retail cocetratio have already bee dealt ith. uch cae, a competitio authority may at to ko the aer to uetio uch a, ill competitio i the retail market eure that pot-merger exercie of buyer poer doe ot harm coumer?, or i a cae here the pre-merger cocetratio i the retail market i high, hould e till be cocered about the exercie of buyer poer eve though the merger doe ot icreae the cocetratio i each retail market? thi paper, e examie the iteractio betee buyer poer i a uptream market ad competitio iteity i a dotream market, ith the aim to hed ome light o the uetio poed above. To do o, e examie four variatio of a model i hich oligopolitic retailer compete i a dotream market ad each retailer pay a liear holeale price for it upplie. We eparate buyer poer from the iteity of dotream competitio by aumig that oly oe of thoe retailer i large ad poee buyer poer agait it upplier. Thi allo u to iolate the effect of retailer buyer poer from thoe aociated ith a chage i the iteity of dotream competitio, ad thu to addre the uetio raied i the precedig paragraph. Our aalyi ho that the holeale ad retail price ideed fall ad coeuetly coumer elfare improve folloig a icreae i the buyer poer of the large retailer. Thi i 4 999, for example, Caada Competitio Bureau approved to merger of grocery retail chai after the mergig partie agreed to divet certai tore i thoe local market here they had igificat overlap. each cae, the to retail chai operated primarily i eparate part of the coutry ad they overlapped i oly a mall umber of local market before the merger Competitio Bureau 999a ad 999b. the U.K., the Competitio Commiio approved the acuiitio of Safeay by Wm Morrio Supermarket coditioal o the divetiture of over 50 tore to addre advere competitio effect of the merger i variou local retail market Competitio Commiio 003.

5 true eve i the cae here the large retailer i a moopoly i the dotream market. Moreover, our aalyi ugget that icreaed dotream competitio brig larger beefit to coumer he buyer poer i preet. additio to reducig retailer markup, icreaed competitio amog retailer force the large retailer to bargai harder ith it upplier to obtai a loer holeale price, hich drive do retail price eve further. Surpriigly, though, it i ot the cae that icreaed buyer poer i more beeficial to coumer he the dotream competitio i more itee. To the cotrary, e fid that the margial effect of a icreae i buyer poer are large he the iteity of dotream competitio i lo, ith the effect beig the larget i the cae of dotream moopoly. Thi ugget that buyer poer ad dotream competitio ca be vieed a ubtitute. The paper i orgaized a follo. ectio, e dicu the relevat literature i more detail. Our aalyi tart i ectio ith a aalyi of a model of homogeeou retailer egagig i uatity competitio. Sectio V, e exted the model to icorporate product differetiatio amog retailer ad coider both uatity competitio ad price competitio. We offer cocludig remark i ectio V.. Literature Revie Our ork i cloely related to vo Uger-Sterberg 996 ad Dobo ad Watero 997. They ho that larger retailer buyer poer, a reflected through a icreae i cocetratio at the retail level, lead to reduced coumer price ad higher ocial elfare oly if the competitio at the retail level i fierce. Specifically, vo Uger-Sterberg 996 compare to theoretical model: oe model here a uptream upplier ell to Courot oligopoly retailer ad the other ith perfect competitio i the retail market. He fid that oly i the model of perfect competitio doe a decreae i the umber of retailer lead to loer coumer price. 3

6 Dobo ad Watero 997 ue a imilar model here a moopoly upplier egotiate ith Bertrad oligopoly retailer ho offer differetiated ervice. Their aalyi ho that coumer price fall ith a reductio i the umber of retailer oly if retailer are coidered by coumer a very cloe ubtitute. Sice Bertrad competitio i the cae of homogeeou firm lead to the ame euilibrium a perfect competitio, thi fidig by Dobo ad Watero ca be vieed a a geeralizatio of vo Uger-Sterberg 996. A poited out by Che 003, the aalye i vo Uger-Sterberg 996 ad Dobo ad Watero 997 capture the combied effect of both buyer poer ad eller poer of retailer a icreaed cocetratio i the retail market ehace both type of market poer imultaeouly. To iolate the effect of buyer poer, Che 003 examie a ituatio here a uptream upplier ell to a group of retailer coitig of a domiat firm ith buyer poer ad a large umber of price-takig frige firm. He demotrate that the preece of dotream competitio by frige retailer i crucial i drivig the elfare effect of buyer poer. 5 Therefore, a commo theme from thee aalye i that competitio i the retail market i eceary for buyer poer to beefit coumer ad improve ocial elfare. Our tudy of the iteractio betee buyer poer ad dotream competitio i alo related to Galbraith 95 cotroverial book o coutervailig poer, i hich he argued that buyer poer a a ubtitute for competitio. hi o ord, i the typical moder market of fe eller, the active retrait [o the exercie of private ecoomic poer] i provided ot by competitor but from the other ide of the market by trog buyer Galbraith 95 p9. Hoever, Galbraith hypothei ha received little upport from the exitig theoretical 5 Specifically, Che 003 ho that a the domiat retailer gai more buyer poer, the retail price ill decreae but the elfare effect ill deped o the market hare of the domiat retailer ad the differece i the cot amog the retailer. Whe the umber of frige retailer i ufficietly large, icreaed buyer poer ill improve ocial elfare. 4

7 aalye of buyer poer. Oe cotributio of the preet paper i that it idetifie a eviromet i hich buyer poer ad competitio ca ideed be vieed a ubtitute.. A Model of Homogeeou Retailer There are to level of market. the dotream market are a group of > retailer. Thee retailer purchae their upplie from the uptream market. thi ectio, e aume that retail ervice are homogeeou ad retailer compete i uatity. Let i i,, deote the uatity old by retailer i, ad i i the total uatity old by all retailer. The ivere demad fuctio i the retail market i repreeted by p doard-lopig, implyig '< 0. The demad curve i. Moreover, e impoe the folloig aumptio o the higher order derivative: '' 0, ''' 0, ad '' / '. 6 t i eay to verify that a liear demad fuctio atifie all of thee aumptio. To eparate the effect of buyer poer from thoe of dotream competitio, e aume that oe of the retailer, retailer R, i i a bilateral moopoly relatiohip ith it upplier, hile the remaiig retailer obtai their upplie i a competitive market. The idea here i that R i a large chai tore that ell i may geographic market, oe of hich i the focu of the preet aalyi. Becaue of it large cale, thi chai retailer i able to iduce a upplier to be it excluive ource of upply. We ue parameter γ to deote the amout of buyer poer R poee agait it upplier. The motivatio for the excluive relatiohip betee retailer R ad it upplier i that it geerate efficiecy gai that loer the upplier uit cot of productio. A poited out by 6 Thee aumptio o the ecod ad third order derivative of eure that the ecod-order coditio of each firm profit-maximizatio problem i atified ad that the pa-through rate of a higher holeale price i maller he the dotream market become more competitive. The role of the pa-through rate i dicued i ectio. after euatio 7. 5

8 Duke et al. 006, a upplier ca achieve reductio i traactio cot he it deal ith a large-volume retailer becaue of ecoomie of cale i traportatio or procuremet cot. Moreover, large retailer, uch a Wal-Mart, are ko to have uperior coumer databae, hich ca help a upplier to loer the cot of reolvig demad ucertaitie ad treamlie the flo of good from ra material to checkout couter Ueem et al Thee efficiecy gai create icetive for R ad a upplier to eter ito a excluive arragemet. Accordigly, e aume that R upplier ha a loer margial cot of productio tha other upplier that ell i the competitive uptream market. Let c deote the margial cot of R upplier ad c the margial cot of other upplier. We aume c < c. To be clear, R upplier ha the freedom to leave the excluive relatiohip ad ell it product i the competitive market. But it ould the forgo the efficiecy gai aociated ith ellig to R, ad ould have the ame uit cot of productio, c, a all other upplier. Each retailer icur to type of cot: the holeale price it pay to it upplier ad a cotat margial cot of providig retailig ervice. The latter i ormalized to zero. 7 The firm i thi model play a to-tage game. At tage, the large retailer R egotiate ith it upplier over the holeale price for the uit old i thi market. At tage, all retailer compete i uatity i the dotream market. We ill model the bargaiig game at tage i to ay. ectio., e take a geeral approach ad potulate that the holeale price i a geeric fuctio of retailer R buyer poer γ ad other parameter of the model, particularly the umber of dotream competitor. ectio., e coider a more pecific model here i determied by the geeralized Nah bargaiig olutio Harayi ad Selto Hece, e aume that all retailer have the ame retailig cot. For a aalyi o ho a differece i retailig cot affect the ditributio of profit amog retailer ad upplier, ee Duke et al

9 Before proceedig to aalyze thi model, e paue to dicu the jutificatio for to aumptio i thi model. Firt, e have aumed that the amout of buyer poer γ i idepedet of the market cocetratio i the dotream market a meaured by. Here e have i mid a ituatio here the buyer poer of a large retailer come from beig i a large umber of market rather tha beig large i a particular market. Thi i motivated, i part, by the obervatio that the coloal cale of retailer uch a Wal-Mart i drive more by the fact that it operate i a large umber of geographic market orldide tha from havig a large market hare i ay particular local market. 8 We uppoe that a icreae i the retailer buyer poer i brought about by it expaio ito a additioal geographic market either through de ovo etry or through the acuiitio of a exitig retailer. Secod, e have aumed that the upplier ad the retailer egotiate over a liear holeale price. o doig, e are folloig the commo approach i may exitig model, uch a vo Uger-Sterberg 996, Dobo ad Watero 997, ad dert ad Valletti 0. reality, cotract betee retailer ad upplier are ofte more complex. We treat the liear price a a approximatio of ituatio here the upplier ad the retailer have a coflict of iteret over the level of the holeale price, ith the upplier preferrig a higher holeale price ad the retailer preferrig the oppoite. A ill be elaborated o i the cocludig remark, our reult are relevat to ituatio of o-liear cotract a log a uch cotract do ot perfectly alig the iteret of the upplier ad the retailer ith regard to the holeale price. 8 deed, early example of retailer poer give by Galbraith 95 ere the major chai tore i the firt half of the 0th cetury, uch a A& ad Sear, Roebuck. thee example, it a their large ize temmig from ellig i may local market that coferred thee retailer the poer to obtai loer price from their upplier. 7

10 . Geeric Bargaiig Fuctio A idicated earlier, e ill firt ue a geeric fuctio to repreet the relatiohip betee R holeale price ad the parameter i the model. Specifically, let W γ, deote thi relatiohip. We upre c ad c i thi fuctio becaue our iteret i i the effect of γ ad. We aume that W γ, atifie the folloig coditio: Aumptio : W / γ < 0. Aumptio : W / < 0. Aumptio : W γ, [ c, c]. Aumptio ay that a icreae i retailer R buyer poer eable it to obtai a loer holeale price. Thi aumptio rule out ituatio here buyer poer ha o impact o the holeale price. Aumptio tate that R holeale price i loer if there are more competitor i the retail competitio. Thi i coitet ith the ituitio that icreaed competitio iteity i the dotream market ould put more preure o both the retailer ad it upplier to reduce the holeale price. Aumptio reflect the idea that retailer R caot force it upplier to accept a price belo the latter margial cot of productio. O the other had, the retailer ould ot at to eter ito the excluive relatiohip if the holeale price i to be higher tha c. Note that i itace here > c, the double margializatio problem exit betee R ad it upplier. By aumig a geeric bargaiig fuctio, e circumvet the eed to pecify a mechaim through hich the retailer large ize tralate ito buyer poer. the literature, it ha bee ho that a larger ize cofer more buyer poer to a retailer becaue it improve the retailer outide optio, tregthe it bargaiig poer or bargaiig poitio, or eake the 8

11 upplier bargaiig poitio Katz 987, dert ad Valletti 0, dert ad Wey 0, ad Che 04. The geeric bargaiig fuctio could be applicable to thee differet mechaim. ectio. ad V, e ill ho that Aumptio to are atified i ituatio here icreaed buyer poer maifet itelf through troger bargaiig poer for R i the geeralized Nah bargaiig problem. Thi i true i all three type of dotream competitio that e ill coider: uatity competitio amog homogeeou retailer, uatity competitio amog differetiated retailer, ad price competitio amog differetiated retailer. 9 To olve the model, e tart ith the ecod tage of the game here each retailer chooe the uatity to ell give the holeale price. Their profit-maximizatio problem are: for retailer R, ad Maxπ Maxπ c i i i i for other retailer R i i,. The firt-order coditio of thee optimizatio problem are: ' 0; 3 ' i c 0 i, The aumptio o the demad fuctio eure that the ecod-order coditio are atified. Sice all retailer other tha R are idetical, they ell the ame uatity i euilibrium. Settig for i, the above euatio implicitly defie ad a fuctio of, c i ad. But give the focu of thi aalyi o buyer poer ad dotream competitio, e ill upre c ad rite the euilibrium uatitie at tage i the form, ad,. 9 Hoever, it i beyod the cope of thi paper to demotrate that thee aumptio hold for every poible mechaim of buyer poer. 9

12 Coductig comparative tatic o 3 ad 4, it i traightforard to fid that, / 0,, / > 0,, / 0 ad, / < 0. other ord, a < < higher holeale price for retailer R decreae it uatity but icreae the uatity of all other retailer. A larger umber of retailer reduce the uatity of every retailer. Uig thee reult, e derive [ [ ] ' '' ' ] ' 0 ' '' ' < 0 ; 5 '' > 0. 6 '' Euatio 5 implie that a higher holeale price for retailer R lead to maller total uatity ad hece higher retail price i euilibrium, hile 6 ay that a larger umber of retailer icreae the total uatity old ad thu reduce the retail price. No e are i a poitio to examie ho buyer poer ad retail market cocetratio affect coumer elfare ad ocial elfare. thi model, coumer elfare ad ocial elfare are repreeted by coumer urplu ad total urplu, repectively. Aumptio ad 5 imply that the ig of p W ' 7 γ γ i egative. Therefore, 0 ropoitio : A icreae i the buyer poer of retailer R reduce the euilibrium price i the retail market. Coumer elfare ad ocial elfare are higher a a reult. A major departure of our model from vo Uger-Sterberg 996 ad Watero ad Dobo 997 i that e have eparate meaure of retailer buyer poer ad retailer eller 0 The proof of all propoitio ad corollarie are relegated to the appedix. 0

13 poer. our model, the buyer poer of R tem from it exteio ito multiple dotream market, rather tha from it expaio i a give dotream market. Accordigly, a icreae i buyer poer i ot accompaied by a imultaeou rie i dotream market poer. That i hy a icreae i buyer poer i our model i geerally beeficial for coumer ad ocial elfare. To be more pecific, a icreae i the buyer poer of retailer R reduce it holeale price, makig itelf a more aggreive competitor i the retail market. Retail price fall becaue of the iteified competitio amog retailer. The loer retail price raie coumer elfare. Moreover, ocial elfare i higher becaue the reductio i holeale price mitigate the double margializtio problem betee retailer R ad it upplier. Turig to the effect of dotream competitio, recall that i Dobo ad Watero 997, a reductio i the umber of retailer ca lead to loer coumer price ad higher ocial elfare if the competitio at the retail level i ufficietly itee. By meaurig buyer poer eparately from the cocetratio i the retail market, our aalyi yield a differet cocluio regardig the impact of icreaed retail cocetratio. ropoitio : A more cocetrated retail market i.e. a maller umber of retailer lead to a higher retail price. Coumer elfare i loer a a reult. Social elfare fall if c c i ufficietly mall. The harm to coumer caued by icreaed retail cocetratio come from to ource, a repreeted by the to term i p W ' '. 8 The firt term o the right-had ide of 8 ay that the retail price i higher becaue the total uatity i maller i a more cocetrated market. Thi i the covetioal ource of harm to

14 coumer. The ecod term i aociated ith buyer poer. t ho that reduced competitio iteity i the retail market allo the large retailer to pay a higher holeale price to it upplier becaue W / < 0, leadig to a further icreae i retail price. The impact of icreaed retail cocetratio o ocial elfare, hoever, i le clear-cut. The ambiguity arie becaue, uder the aumptio c > c, the icreaed cocetratio i aociated ith the elimiatio of a retailer hoe upplier ha higher margial cot tha that of the large retailer. Thi geerate a efficiecy gai that mitigate the lo aociated ith the leeig of competitio. But thi efficiecy gai ould ot be ufficiet to completely offet the lo if the differece i margial cot c c i mall. Later i ectio. here the holeale price i determied by the geeralized Nah bargaiig olutio, e ill preet a precie coditio o c c uder hich ocial elfare fall uambiguouly. ropoitio ad have iteretig policy implicatio. Merger revie by competitio authoritie i may coutrie have traditioally focued o market poer o the eller ide rather tha o the buyer ide. the cae of a merger betee to retailer, thi approach typically ivolve the examiatio of idividual geographic market to eure that after the merger, there i ufficiet competitio amog retailer i each local market. ropoitio ad combied ugget that thi traditioal approach to merger revie ca actually ork reaoably ell eve i a ituatio here the merger alo ehace the buyer poer of the merged etity. By prevetig the dotream market from becomig more cocetrated, the competitio authority ould eure that the pot-merger retail price ill ot rie ad may poibly fall. Thi ca be ee from the cat attetio paid to buyer poer i the merger eforcemet guidelie i Caada, the EU ad the US.

15 Fially, e examie the iteractio betee buyer poer ad the iteity of dotream competitio. The uetio e at to addre here i hether the impact of buyer poer i larger or maller he the retail market become more cocetrated. ropoitio 3: f W / γ > 0, the reductio i retail price i repoe to a icreae i the buyer poer of retailer R decreae ith the umber of retailer; i other ord, the maller i the umber of retailer, the greater i the reductio i retail price. ropoitio 3 ugget that he the dotream market i le competitive, a icreae i buyer poer may brig about a greater decreae i retail price ad coeuetly a larger gai i coumer urplu. Thi reult i urpriig becaue ituitively the preure for a retailer to pa o the cot avig from a loer holeale price to coumer i troger he there i more itee competitio amog retailer. Thi ituitio might ugget that the reductio i retailer price reulted from the exercie of buyer poer hould be maller he the retail market i le competitive. Hoever, thi ituitio mie the fact that the margi betee the retail price ad the margial cot of productio i alo higher he the retail market i le competitive. Hece, there i more room for the retail price to fall i repoe to the icreaed buyer poer, ad ropoitio 3 ho that thi i ideed hat happe i euilibrium if W / γ > 0. Note that W / γ i the derivative of W / γ ith repect to ad the ig of W / γ i egative. Hece, W / γ > 0 implie that a icreae i buyer poer brig about a larger reductio i holeale price he the retail market i more cocetrated. A larger reductio i holeale price the lead to a greater fall i the retail price. Here e implicitly hold the pa-through rate p / cotat. ectio., e ill preet a more complete explaatio of ropoitio 3 that take ito coideratio the chage i the pa-through rate. 3

16 Thi beg the uetio, doe W / γ > 0 hold uder plauible circumtace? Belo e ill ho that thi i ideed true i cae here the demad fuctio i liear ad the holeale price i determied by geeralized Nah bargaiig olutio.. Geeralized Nah Bargaiig ith Liear Demad Fuctio No e aume that the outcome of the egotiatio at tage i determied by the geeralized Nah bargaiig olutio. order to derive a cloed-form olutio to the holeale price, e coider a liear demad fuctio, a b ith a > 0 ad b > 0. To eure that every retailer ell a poitive uatity i euilibrium, e aume that a > c c. Let π ad π deote the profit of retailer R ad it upplier, repectively. Becaue of their excluive relatiohip, their diagreemet payoff i.e., their iide optio are both zero. The upplier ha the outide optio of producig ad ellig the good i the competitive market. But i doig o, the upplier ould loe the efficiecy gai aociated ith the excluive relatiohip ad thu it ould be jut like other upplier ith margial cot c. The outide optio of retailer R i to purchae the good i the competitive market at the price c. 3 Takig ito coideratio the Outide Optio riciple Bimore et al. 986, e rite the geeralized Nah bargaiig problem a: γ Maxπ γ π ubject to c c, 9 here γ 0, meaure R relative bargaiig poer. Recall that i ectio., γ i the meaure of the retailer buyer poer agait it upplier. Accordigly, here e ue retailer R bargaiig poer a the meaure of it buyer poer. 3 Strictly peakig, iide optio ad outide optio are cocept i o-cooperative bargaiig theory. Hoever, a explaied i Muthoo 999, the iide optio poit correpod to the diagreemet poit, ad the outide optio poit cotrai the et of poible agreemet i the Nah bargaiig problem. The latter reult i ko a the Outide Optio riciple. That i hy the iide optio eter the Nah product hile the outide optio are icluded a cotrait i 9 belo. 4

17 We offer three jutificatio for thi approach. The firt jutificatio i baed o the ellko obervatio that the geeralized Nah bargaiig olutio ca be derived from the euilibrium i the Rubitei bargaiig game i the limit cae here the duratio betee offer ad couter-offer i ifiiteimally mall ee, e.g., Muthoo 999. The player relative bargaiig poer i the a fuctio of their time dicout rate. t eem plauible that a a retailer become larger, it ill be able to acce the capital market at a loer rate of iteret, hich implie a maller time dicout rate. Thi, i tur, tralate ito troger bargaiig poer for the retailer. Next, a ho i Che 04, a larger retailer ha a troger icetive to ivet i the uality of it egotiatio team, thu leadig to troger bargaiig poer. Fially, eve if the buyer poer maifet itelf through other chael, it ultimately icreae the retailer lice of the pie. 4 Thu, a larger γ i a reaoable proxy for a icreae i buyer poer i uch ituatio. Uig the liear demad fuctio, e olve the Courot euilibrium at tage to fid a c a c ; ; 0 b b a c p. Subtitutig 0 ad ito R ad it upplier profit, e ca olve the geeralized Nah bargaiig problem 9. We do o i to tep. Firt, e uppoe that the cotrait i 9 are ot bidig ad derive the Nah bargaiig olutio uder the aumptio that c < < c : 4 the literature, a umber of author have examied the ource of buyer poer. They iclude Katz 987, Chipty ad Syder 999, Motez 007, dert ad Wey 007 ad 0, dert ad Valletti 0, ad Che 04. Amog them, Motez 007 poe the uetio, Why bake a larger pie he gettig a maller lice? 5

18 γ γ W γ, [ a c]. N c Secod, e ivetigate hether the olutio atifie thi aumptio. Uig, e ca verify that N > c, idicatig that the upplier outide optio i ot bidig i euilibrium. O the other had, N c implie that γ γ L, here a c c c γ L. 3 a c c c Thu, retailer R outide optio i ot bidig oly if it buyer poer exceed the threhold give i 3. 5 the cae here it buyer poer i belo thi threhold, the Outide Optio riciple implie that the egotiated holeale price ould be c, ad the euilibrium i idepedet of R buyer poer. thi cae, a mall icreae i the buyer poer ould have o effect a log a the icreaed value of γ doe ot exceed γ L. With regard to Aumptio, e differetiate to fid W γ, γ a c c < 0. 4 Accordigly, Aumptio i atified a log a γ γ L. eece, thi aumptio eure that retailer R ha a meaigful amout of buyer poer that ould allo it to have a material ifluece o the holeale price. Differetiatig ith repect to, e obtai: W γ, γ a c < 0, 5 implyig that Aumptio i atified. The cotrait i 9 eure that Aumptio hold a ell. 5 t i eay to ee from 3 that γ L <. Moreover, γ γ L i a bidig cotrait oly if the umerator of 3 i poitive, i.e., oly if a c > c c. 6

19 Sice Aumptio are all atified, e coclude that ropoitio -3 hold i the preet cae. Furthermore, it i eay to ho that the coditio pecified i ropoitio 3, W γ, γ a c > 0 6 i ideed true. Therefore, Corollary : Suppoe that the demad fuctio i liear ad the holeale price i determied by the geeralized Nah bargaiig olutio. The the maller i the umber of retailer, the greater i the reductio i the holeale ad retail price i repoe to a icreae i the buyer poer of retailer R. To gai a more precie, ad more complete, udertadig of the ituitio behid ropoitio 3 ad Corollary, ote that the euilibrium retail price ca be vieed a a fuctio of W γ, ad. To be more pecific, uig ad e ca rite the euilibrium ~ retail price i the form W γ,,. Notig that ~ / 0, e have ~ ~ ~ W γ,, W W. 7 γ γ γ The right-had ide of 7 idetifie to chael through hich dotream competitio ifluece the margial impact of buyer poer o retail price. Firt, a more cocetrated retail market i.e., a maller elarge the reductio i holeale price aociated ith a icreae i buyer poer, a idicated by 6. Holdig the pa-through rate ~ / cotat, thi lead to a larger decreae i the retail price. Secod, the pa-through rate itelf i affected by the umber of retailer. From e obtai: ~ < 0, 8 7

20 hich implie that for a give reductio i holeale price, the retail price fall by a larger magitude he there are feer retailer. both itace, therefore, a icreae i buyer poer lead to a larger reductio i the retail price he the market i more cocetrated. The policy implicatio of ropoitio 3 ad Corollary i iteretig. t ugget that a competitio authority doe ot ecearily have to be more cocered about the effect of buyer poer i a more cocetrated retail market. A cocetrated retail market i ot deirable i term of coumer ad ocial elfare. But a merger that ehace the buyer poer of the merged etity ithout icreaig the cocetratio i the retail market ca be a good thig. ropoitio 3 ad Corollary alo ugget that buyer poer ad dotream competitio ca be vieed a ubtitute i term of their effect o coumer. The idea that buyer poer ad competitio are ubtitute i a major compoet of Galbraith 95 coutervailig poer hypothei. So far, hoever, thi idea ha received very little theoretical upport. Our aalyi itill more rigor to the meaig of thi idea ad idetifie a eviromet here it hold true. With the additioal tructure of liear demad fuctio ad Nah bargaiig olutio, e are able to be more pecific about the coditio give i ropoitio. Corollary : Suppoe that the demad fuctio i liear ad the holeale price i determied by the geeralized Nah bargaiig olutio. The a more cocetrated retail market reduce ocial elfare if c c < a c /. Give the reult e have obtaied o far, it i atural to ak, hat ould happe if the dotream market i erved by a moopoly? To put it differetly, ca a merger to moopoly be vieed a the limit cae of a icreae i cocetratio i the oligopolitic retail market? The aer, it tur out, i ye. ropoitio 3 ad Corollarie cotiue to hold for the merger to moopoly. Mathematically, our model of oligopolitic retailer coverge to 8

21 that of a moopoly he. other ord, e ca obtai the euilibrium price ad uatitie uder a moopoly by ettig i 0. Three implicatio of the precedig paragraph are orth otig. Firt, a icreae i the buyer poer of the moopoly retailer reduce euilibrium holeale price ad retail price, ad improve both coumer ad ocial elfare. other ord, the effect of buyer poer i the cae of a moopoly retailer are ualitatively the ame a thoe i the oligopolitic retail market. Thi cocluio i i harp cotrat to vo Uger-Sterberg 996 ad Dobo ad Watero 997 i hich icreaed buyer poer i a highly cocetrated retail market i detrimetal to coumer ad ocial elfare. Secod, a icreae i the buyer poer of retailer R caue a greater reductio i the holeale ad retail price i the moopolitic retail market tha i the oligopolitic retail market. Therefore, the beefit of icreaed buyer poer to coumer i the larget he the competitio i the retail market i the eaket. Third, if a merger to moopoly i thi retail market alo ehace R buyer poer, it ould have ambiguou effect o coumer elfare ad ocial elfare. O the oe had, the icreaed retail cocetratio ould harm coumer ad reduce total urplu uder the coditio pecified i ropoitio or Corollary. O the other had, the ehaced buyer poer beefit coumer ad icreae ocial elfare. The et impact, of coure, ill deped o the magitude of the buyer poer effect relative to that of icreaed cocetratio. V. roduct Differetiatio While the homogeeou retailer model tudied i ectio ha the advatage of implicity ad elegace, it mie a importat characteritic of may retail market, amely product 9

22 differetiatio amog retailer. reality, retailer ca be differetiated i everal apect, uch a locatio ad ervice. thi ectio, e exted our aalyi to take ito accout retailer differetiatio. Specifically, uppoe that retailer i,,, face the folloig ivere demad fuctio: p a, 9 i i here θ 0, meaure the degree of ubtitutability betee to retailer. The larger i the value of θ, the higher i the degree of ubtitutability. Ule pecified otherie, the remaiig apect of the model are the ame a thoe i ectio.. j i thi model of differetiated retailer, e ill coider both uatity competitio ad price competitio i the dotream market. Becaue of pace limit, e ill focu our dicuio o the robute of our mot iteretig reult from ectio, i.e., thoe regardig the iteractio betee buyer poer ad dotream competitio i particular, ropoitio 3 ad Corollary. j V. uatity Competitio Here e cotiue to aume that the retailer compete i uatity. To ditiguih from the cae of homogeou retailer, e ue upercript C to deote the euilibrium i the cae of uatity competitio amog differetiated retailer. Solvig the euilibrium at tage uig the demad fuctio 9, e obtai: C a a c ; [ ] C a c c. 0 [ ] Sice c, the aumptio a > c c eure that i poitive for ay θ 0,. C Subtitutig 0 ito the profit of retailer R ad it upplier, e olve 9 to fid the Nah bargaiig olutio i thi cae: 0

23 C W C γ θ a c γ, γ a γ c. θ A i ectio., the cotrait c hold a log a the buyer poer exceed a certai threhold, i.e., C γ γ L here A i ectio., e aume C θ a c θ θ c c γ L. θ a c θ θ c c C γ γ L to focu o the ituatio here R ha a meaigful amout of buyer poer to be able to ifluece it o holeale price. 6 From, e fid C W γ θ θ [ θ a c θ c c ] < 0. 3 A i the cae of homogeeou retailer, a icreae i R buyer poer reduce it holeale price. Thi eable u to obtai the folloig reult. ropoitio 4: Suppoe that retailer are differetiated ad they compete i uatity. The p C i γ C C pi < 0; > 0; > 0 γ γ i,, ropoitio 4 tate that a icreae i the buyer poer of retailer R reduce ot oly it o retail price but alo the price of all other retailer. The maller i the umber of retailer, the greater i the reductio i the holeale price ad the retail price i repoe to a icreae i R buyer poer. Thee fidig are, of coure, ualitatively the ame a thoe i ectio. 6 C C t ca be ee from that γ L <. Moreover, γ γ L i bidig oly if the umerator of i poitive, i.e., oly if θ a c > θ θ c c.

24 V. rice Competitio No uppoe that the retailer egage i price competitio. To olve the Bertrad competitio euilibrium at tage, e ivert the ivere demad fuctio 9 to obtai the folloig demad fuctio θ a [ θ ] pi θ p j i j θi. 5 θ θ θ We ue upercript B to deote the euilibrium uder price competitio. At tage of the game, each retailer chooe it price to maximize it profit. Solvig thee profit-maximizatio problem, e fid the euilibrium price at tage : p B θ [ θ 3] a θ [ θ ] c [ θ ][ θ ] ; 6 [ θ ][ θ ] θ θ [ θ 3] a [ θ ] c θ[ θ ] p B, 7 [ θ ][ θ ] θ here B p i the price of retailer R i i,. A ca be ee from 6 ad 7, the algebra i the cae of price competitio i more itricate tha that of uatity competitio. To make the aalyi tractable, e ue a lightly impler verio of the geeralized Nah bargaiig problem to determie the holeale price. Specifically, e aume that retailer R ad it upplier egotiate over the plit of per uit urplu p c. other ord, e coider the folloig bargaiig problem: max p γ c γ ubject to c c. 8 Uig the ame procedure a i ectio., e fid the euilibrium holeale price: B W B θ [ θ 3] a θ [ θ ] c γ, γ γc, 9 [ θ ][ θ ] θ

25 B B provided that the value of γ exceed a certai threhold, γ L. The precie expreio of γ L i uite complicated ad thu i relegated to the appedix. Uig 6, 7 ad 9, e are able to obtai the folloig reult that are ualitatively the ame a ropoitio 4. ropoitio 5: Suppoe retailer are differetiated ad they compete i price. The p B i γ B B pi < 0; > 0; > 0 γ γ i,, ropoitio 4 ad 5 demotrate that our mai fidig i ectio are robut to the icorporatio of retailer product differetiatio ad are valid uder both uatity competitio ad price competitio. Larger buyer poer i the had of retailer R l reduce the price of all retailer. The maller i the umber of retailer, the greater i the reductio i the holeale ad retail price i repoe to a icreae i R buyer poer. V. Cocludig Remark By tudyig four variatio of a model that iolate the effect of buyer poer from thoe of the dotream competitio, e have demotrated that ehaced buyer poer of a large retailer reduce retail price ad improve coumer elfare, ad thi i true eve i the cae here the retail market i erved by a moopolit. More iteretigly, the beeficial effect of the icreaed buyer poer o coumer elfare i larger he the iteity of dotream competitio i loer, ith the effect beig the larget i the cae of dotream moopoly. Our aalyi provide a aer to the policy uetio poed i troductio. Firt, it ugget that the traditioal approach to merger revie, uder hich a competitio authority focue o maitaiig competitio i local retail market, ca ork reaoably ell eve i a ituatio here the merger ehace the buyer poer of the merged etity i the uptream 3

26 market. By prevetig the dotream market from becomig more cocetrated, the competitio authority ca eure that pot-merger retail price ill ot rie ad may eve fall. Secod, the competitio authority doe ot ecearily have to be more cocered about the effect of buyer poer i a more cocetrated retail market. A cocetrated retail market i ot deirable, but a merger that that ehace the buyer poer of the merged etity ithout icreaig the cocetratio i the retail market ca mitigate the egative effect of high cocetratio. Third ad fially, it i ot ecearily the cae that a icreae i buyer poer i more beeficial to coumer ad ocial elfare he the dotream competitio i more itee. our model, the oppoite i true; that i, the beeficial effect of a icreae i buyer poer are larger he the dotream competitio i le itee. A importat aumptio i our model i that a per-uit price i ued i the cotract betee the large retailer R ad it upplier. f e chage thi aumptio ad uppoe, itead, that the cotract take the form of a to-part tariff, the euilibrium ca be ualitatively differet. Specifically, the retailer ad the upplier may be able to et the holeale price to maximize their joit-profit ad ue the fixed fee to divide the joit profit. f thi i the cae, a icreae i the retailer buyer poer ill imply elarge it hare of the joit profit, but it ill have o impact o retail price or elfare. A to-part tariff ad a igle per-uit price repreet the to extreme i the ability of the retailer ad the upplier to reolve their coflictig iteret over the holeale price. With a to-part tariff, they may be able to alig their iteret perfectly ad chooe the holeale price that maximize their joit profit. With a igle per-uit price, o the other had, their 4

27 iteret are diametrically oppoed, ith the upplier preferrig a higher ad the retailer preferrig a loer holeale price. t i a empirical uetio hether a retailer ad it upplier are alay able to alig their iteret perfectly regardig hat the appropriate level of holeale price hould be. While it i true that cotract betee retailer ad their upplier ofte cotai more term of trade tha a igle per-uit price, there are importat exceptio. Wal-Mart, for example, i famou for boilig everythig do to a holeale price i their egotiatio ith upplier Ueem et al Eve ith more complex cotract, retailer ad their upplier do ot alay achieve perfect aligmet of their iteret due to variou iformatio ad icetive iue that exit i the real orld. deed, evidece ho that iefficiecie exit i the relatiohip betee retailer ad their upplier Buzzell et al. 990, ad Daar ad Storelli 03. The reult e have obtaied i thi paper ould cotiue to hold ualitatively a log a the cotract betee the upplier ad the retailer doe ot lead to a perfect aligmet of their iteret regardig the holeale price. uch a ituatio, a icreae i the retailer buyer poer ill maifet itelf, at leat i part, through a loer holeale price, ad the loer holeale price ill have the effect examied i thi paper. 5

28 Referece Battigalli, ierpaolo, Chiara Fumagalli, ad Michele olo 007 Buyer oer ad uality mprovemet, Reearch i Ecoomic, 6, Bimore, Ke, Ariel Rubitei, ad Aher Wolikky 986 The Nah Bargaiig Solutio i Ecoomic Modellig, RAND Joural of Ecoomic, 7, Buzzell, Robert D., Joh uelch, ad Walter J. Salmo 990 The Cotly Bargai of Trade romotio, Harvard Buie Revie, March-April 990. Che, Zhii 003 Domiat Retailer ad the Coutervailig oer Hypothei, RAND Joural of Ecoomic, 34, Che, Zhii 007 Buyer oer: Ecoomic Theory ad Atitrut olicy, Reearch i La ad Ecoomic,, Che, Zhii 04 Supplier ovatio i the reece of Buyer oer, Carleto Ecoomic aper, Chipty, Taeem ad Chritopher M. Syder 999 The Role of Outlet Size i Bilateral Bargaiig: A Study of the Cable Televiio dutry, Revie of Ecoomic ad Statitic, 8, Competitio Bureau 999a Backgrouder: Lobla Compaie Limited Acuiitio of rovigo c. i uebec ad Otario, publihed o Augut, 999, vieed at Competitio Bureau 999b Backgrouder: Sobey c. Acuiitio of Certai Aet of the Ohaa Group Limited, publihed o December, 999, vieed at 6

29 Competitio Commiio 003 Safeay plc ad Ada Group Limited Oed by Wal-Mart Store c; Wm Morrio Supermarket LC; J Saibury plc; ad Teco plc: A Report o the Merger i Cotemplatio, vieed at Daar, Niraj ad Jao Storelli 03 Rebuildig the Relatiohip betee Maufacturer ad Retailer, MT Sloa Maagemet Revie, December 03 Dobo, aul W. ad Michael Watero 997 Coutervailig oer ad Coumer rice, Ecoomic Joural, 07, Duke, A.J., E. Gal-Or ad K. Sriivaa 006 Chael Bargaiig ith Retailer Aymmetry, Joural of Marketig Reearch, 43: Erutku, Ca 005 Buyig oer ad Strategic teractio, Caadia Joural of Ecoomic, 38, Galbraith, J.K. 95 America Capitalim: The Cocept of Coutervailig oer, Boto: Houghto Miffli. Harayi, J.C. ad R. Selto 97, A Geeralized Nah Solutio for To-ero Bargaiig Game ith complete formatio, Maagemet Sciece, 8, dert, Roma ad Greg Shaffer 007 Retail Merger, Buyer oer ad roduct Variety, Ecoomic Joural, 7, dert, Roma ad Tommao M. Valletti 0 Buyer oer ad the Waterbed Effect, Joural of dutrial Ecoomic, 59, -0. dert, Roma ad Chritia Wey 007 Buyer oer ad Supplier cetive, Europea Ecoomic Revie, 5,

30 dert, Roma ad Chritia Wey 0 Coutervailig oer ad Dyamic Efficiecy, Joural of the Europea Ecoomic Aociatio, 9, Katz, Michael L. 987 The Welfare Effect of Third Degree rice Dicrimiatio i termediate Good Market, America Ecoomic Revie, 77, Mill, David E. 00 Buyer oer ad dutry Structure, Revie of dutrial Orgaizatio, 36, 3-5. Motez, João V. 007 Dotream Merger ad roducer Capacity Choice: Why Bake a Larger ie Whe Gettig a Smaller Slice? RAND Joural of Ecoomic, 38, Muthoo, Abhiay 999 Bargaiig Theory ith Applicatio, Cambridge: Cambridge Uiverity re. OECD 998 Roudtable o Buyig oer of Multiproduct Retailer, vieed at OECD 004 Roudtable o Competitio ad Regulatio i Agriculture: Moopoy Buyig ad Joit Sellig, vieed at OECD 008 olicy Roudtable: Moopoy ad Buyer oer, vieed at Smith, Hoard ad Joh Thaaouli 009 Uptream Competitio ad Dotream Buyer oer, Uiverity of Oxford Ecoomic Serie Workig aper 40. Ueem, Jerry, Julie Schloer, ad Hele Kim 003 Oe Natio uder Wal-Mart, Fortue, 474, vo Uger-Sterberg, Thoma 996 Coutervailig oer Reviited, teratioal Joural of dutrial Orgaizatio, 4,

31 9 Appedix roof of ropoitio ad Corollarie roof of ropoitio : The firt tatemet of thi propoitio follo from 7. Coumer elfare i meaured by coumer urplu, give by dx x CS 0. A By Aumptio ad euatio 5, e fid that 0 ' > γ γ W CS. A Social elfare i meaured by total urplu, hich ca be ritte a c c dx x TS ] [ ] [ 0. A3 Differetiatig A3 ad ue the retailer optimizatio coditio, e obtai 0 ' ' > γ γ γ γ W c W W TS. A4 The ig of A4 i determied by 5, 0 / <, 0 / >, Aumptio ad, ad becaue c. ED roof of ropoitio : The firt tatemet of thi propoitio follo from Aumptio, 5, 6 ad 8. Differetiatig A ith repect to, e obtai: 0 ' > W CS, A5 the ig of hich i determied by 5, 6 ad Aumptio. Differetiatig A3 to fid:. ' ' W c W W TS A6

32 30 The ig of the firt to term o the right-had ide of A6 are poitive, hile the ig of the third term i idetermiate. Hoever, the third term vaihe if c c i hich cae c by Aumptio. By cotiuity, 0 / > TS if c c i ufficietly mall. ED roof of ropoitio 3: From 5, e derive 0 '' ' '' ' ' ' > p. A7 Differetiatig A7 ith repect to ad repectively, e fid [ ] [ ] [ ] 0 '' ' '' ' / ''' ' ' '' '' p ; A8 [ ] [ ] [ ] 0 '' ' '' ' ' / ''' ' ' '' '' < p. A9 No differetiate 7 to obtai: γ γ γ W p W p W p p. A0 The ig of the firt term o the right-had ide of A0 i poitive by A8, A9 ad Aumptio ad. The ig of the ecod term i poitive a ell if 0 / > γ W. Hece the ig of A0 i poitive uder the ame coditio. ED roof of Corollary : Follo from 6 ad ropoitio 3. ED roof of Corollary : Uig the liear demad fuctio, e rite the total urplu a: 0 c c dx bx a TS. A Differetiate A to obtai: W b c c c p b c c p c a TS N, A

33 hich i poitive if p c c > 0. Uig, e ca ho that the latter hold for all γ 0, if c c < a c /. ED roof of ropoitio 4: To implify preetatio, defie Z θ [ θ ]. Uig 9, 0 ad 3, e fid: C p γ C θ θ θ W Z γ C C p θ W < 0 ; < 0. A3 γ Z γ From 3, e obtai: The A3-A4 imply a c W C θ θ > 0. A4 γ θ θ C p γ C Z W Z γ C W γ [ θ θ θ ] θ θ > 0 ; A5 C p γ Z C W θz θ θ γ C W γ > 0. A6 ED roof of ropoitio 5: Defie T [ θ ][ θ ] θ ; A7 Y θ [ θ 3] a θ [ θ ] c. A8 t i eay to verify that T > 0 ad that Y / T > c. The the holeale price i 9 ca be ritte a W B B γ, γ Y / T γ c. Sice Y / T > c ad c > c, e coclude that W γ, > c for γ 0,. The threhold γ i obtaied by olvig γ Y / T γ c c, hich yield: B L B Y Tc γ L. A9 Y Tc 3

34 Differetiatig 9, e fid: B W γ, γ Y T c < c c < 0. A0 From A0, e obtai W γ, γ θ θ G > 0, A T here G [ θ 6 5 θ 4 7 ] a [ θ 6 5 θ 3] c, hich i poitive becaue a > c. Defie S [ θ ][ θ ] θ. Differetiatig 6, e obtai The from A0-A, e fid: p B θ 3θ W γ, < 0. A γ S γ B p γ θ S T { GS θ [ θ 3θ ] Y Tc Tθ[ θ 3θ ] }, A3 hich i clearly poitive if θ 3θ 0. the cae here θ 3θ < 0, e ca ho that θ [ θ 3θ ] > θ [ θ 3θ ]. Moreover, it ca be verified that G > Y Tc ad S > T. Thee imply that A3 i poitive i thi cae a ell. Regardig the price of the retailer other tha R, e obtai from their bet repoe fuctio at tage p B θ a [ θ ] c θp θ B. A4 B Differetiatig A4 ad uig A-A3, e ca verify that p / γ < 0 ad p B / γ > 0. ED 3