Structural analysis, of manufacturer pricing in the presence of a strategic retailer

Consumer goods manufacturers usually sell their brands, to, consumers throu gh common independent retailers. Theoretical research on such channel struc tures, has analyzed the optimal behavior of channel members under alternati ve assumptions of manufacturer-retailer interaction (Vertical Strategic Int eraction). Research in Empirical Industrial Organization has focused on ana lyzing the competitive interactions between manufacturers (Horizontal Strat egic Interaction). Decision support systems have made various assumptions a bout retailer-pricing rules (eg, constant markup category-profit maximizati on). The appropriateness of such assumptions about strategic behavior for a ny specific market, however, is an empirical question. This paper therefore empirically infers (1) the Vertical Strategic Interaction (VSI) between ma nufacturers and retailer, (2) the Horizontal Strategic Interaction (HSI) be tween manufacturers simultaneously with the VSI, and (3) the pricing rule u sed by a retailer. The approach is particularly appealing because it can be used with widely a vailable scanner data, where there is no information on wholesale prices. R esearchers usually have no access to wholesale prices. Even manufacturers, who have access to their own wholesale prices, usually have limited informa tion on competitors` wholesale prices. In the absence of wholesale prices, we derive formulae for wholesale prices using game-theoretic solution techn iques under the specific assumptions of vertical and horizontal strategic i nteraction and retailer-pricing rules. We then embed the formulae for whole sale prices into the estimation equations. While our empirical illustration is using scanner data without wholesale prices, the model itself can be ap plied when wholesale prices are available. Early research on the inference of HSI among manufacturers in setting whole sale prices using scanner data (e.g, Kadiyali et al. 1996, 1999) made the s implifying assumption that retailers charge a constant margin. This assumpt ion enabled them to infer wholesale prices and analyze competitive interact ions between manufacturers. In this paper, we show that this model is econo metrically identical to a model that measures retail-price coordination acr oss brands. Hence, the inferred cooperation among manufacturers could be ex aggerated by the coordinated pricing (category management) done by the reta iler. We find empirical support for this argument. This highlights the need to properly model and infer VSI simultaneously to accurately estimate. the HSI when using data at the retail level. Functional forms of demand have been evaluated in terms of the fit of the m odel to sales data. But recent theoretical research on channels (Lee and St aelin 1997, Tyagi 1999) has shown that the functional form has serious impl ications for strategic behavior such as retail passthrough. While the logit and linear model implies equilibrium passthrough of less than 100% (Lee an d Staelin call this Vertical Strategic Substitute (VSS)), the multiplicativ e model implies optimal passthrough of greater than 100% (Vertical Strategi c Complement (VSC)). Because passthrough rates on promotions have been foun d to be below or above 100% (Chevalier and Curhan 1976, Armstrong 1991), we empirically test the appropriateness of the logit (VSS) and the multiplica tive (VSC) functional form for the data. We perform our analysis in the yogurt and peanut butter categories for the two biggest stores in a local market. We found that the VSS implications of the logit fit the data better than the multiplicative model. We also find that for both categories, the best-fitting model is one in which (1) the re tailer maximizes category profits, (2) the VSI is Manufacturer-Stackelberg, and (3) manufacturer pricing (HSI) is tacitly collusive. The fact that the retailer maximizes category profits is consistent with theoretical expecta tions. The inference that the VSI is Manufacturer-Stackelberg reflects the institutional reality of the timing of the game. Retailers set their retail prices after manufacturers set their wholesale prices. Note that in the st ores and product categories that we analyze, the two manufacturers own the dominant brands with combined market shares of about 82% in the yogurt mark et and 65% in the peanut butter market. The, result is also consistent with a balance of power argument the literature. The finding that manufacturer pricing is tacitly collusive is consistent with the argument that firms inv olved in long-term competition in concentrated markets can achieve tacit co llusion. Managers use decision support systems for promotion planning that routinely make assumptions about VSI, HSI, and the functional form. The results from our analysis are of substantive import in judging the appropriateness of a ssumptions made in such decision support systems.