Buyer power : economic theory and competition policy towards the retail sector

• Main Author: Mazzarotto, Nicola
• Published: University of East Anglia 2005
• Subjects: 381.1094
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.437833

The main international antitrust institutions within the last ten years have all devoted significant resources to solving one particular problem. The problem of how to treat antitrust cases, and in particular merger cases, that involved firms operating in the retail sector has been considered in Britain by the Office of Fair Trading and the Competition Commission, in the US by the Federal Trade Commission, by the Directorate General Competition (DGComp) in the European Union, and finally, in an attempt to compare and coordinate international approaches, by the OECD. At the same time, independent academic research had also started to devote more attention to the economic theory that could be employed to analyse the retail sector. An important factor behind this relatively sudden growth of interest in the economics of the retail sector has been the sharp rise in concentration that the food retail sector in particular has experienced in most western economies during the past 20 years or so. The change in concentration was accompanied by a change in consumers' shopping habits and has brought about a change in business practices, in particular in retailers' relations with suppliers. This is not a change that has taken place everywhere. Concentration indexes vary substantially across European states. Great Britain is one of those markets where the retail sector is relatively mature with retail chains dominating the marketplace at the national level. At the other end of the spectrum lie countries such as Spain, Greece, and 5 Nicola Mazzarotto © 2005 Italy where concentration is still relatively low and consumers' shopping habits appear to still be quite traditional. Changes in business relations have, in some cases, been met by organized political responses. In both France and the UK, farmers' associations have complained strongly of an alleged monopolistic power that national retail chains exploited to impose unfair contract terms upon their members. In the UK, consumers associations organised the "rip off Britain" campaign with the aim of tackling the supposed monopolistic origin of international price differentials. For most antitrust authorities in the second half of the 1990s the need was urgent to find a framework within which to analyse mergers between retail chains in markets where concentration was already high. These mergers involved issues that were not much treated by economic theory, such as the role of specific contractual clauses imposed by retailers on their suppliers or, more generally, the implications of "buyer power". Buyer power can be thought of, broadly speaking, as the market power that retailers enjoy vis-ä-vis their suppliers, for competition. Despite being used in different contexts, however, this term does not always carry the same meaning. The first chapter discusses the use of this term by antitrust authorities, before reviewing the most relevant theoretical literature that has addressed the issue of buyer power in recent years. In 1999, following a first wave of independent as well as commissioned theoretical research, the European Commission's DGComp was given the opportunity of employing it by the notification of a merger between two major Austrian supermarket chains: Rewe-Billa and Meinl. Chapter 2 analyses the principles of this decision' in detail. This chapter also argues that the principles established in this decision are representative of the Commission's "approach" as they were subsequently utilised to assess other mergers in food retailing as well as in other retail sectors. This Decision represents, in my view, an opportunity for two main reasons. First, it allows us to clearly identify the principles upon which the Commission, more or less explicitly, judges a retail merger to be anticompetitive and allows us to check whether these principles are supported by economic theory. Second, it allows us to identify where policy implementation could benefit from further developments in economic theory. Chapter 2 is motivated by these two ideas. It highlights areas where the Commission's approach seems weak. These are mainly in the field of market definition, ' Decision1 999/674/EC- Rewe/Mein(lO J L 274/1,23/10/1999). at various stages of the supply chain, and in its use of the theory on buyer power. These themes then inform the theoretical work in the subsequent chapters. The third chapter focuses on market definition, analysing the Commission's practice by reference to a simple stage-game model of bargaining between a single manufacturer and several retailers. The results show that the Commission's approach to market definition at the procurement level, i. e. where retailers act as buyers from manufacturers, can give misleading results in the competitive assessment of the merger if the assumption that the Commission makes on the origin of buyer power is violated. This assumption states that buyer power originates from the size of the orders that a buyer can place In simple terms: the larger buyer pays the lower price. In the second chapter an alternative view is put forward, which stresses the importance of competitive conditions in differentiated markets. If retailers are asymmetric in that they sell in distribution markets that differ for their degree of seller market power, and their bargaining power vis-a-vis suppliers is linked to those competitive conditions, then the Commission's approach may not capture buyers' dominance in the intermediate market and may give misleading indications. This chapter then suggests some changes to the Commission's practice of defining procurement markets that could address the current shortcomings. The fourth chapter extends the model of chapter 3 to look at retailers' procurement strategies. In the Rewe/Meinl decision it was reported that Rewe did not coordinate the purchases of its international subsidiaries when buying from large international producers. This is a puzzling fact when one thinks that buyer power is directly related to buyer's size. However, chapter 4 shows that if buyer power is determined by competitive conditions in the distribution markets, then not to coordinate international purchases can be a profit maximising strategy. The fifth chapter addressesth e issue of the origin of buyer power formally and in a more general setting. In the model retailers compete for final consumers around a circle and bargain with a single monopolist manufacturer, over a linear price and a two-part tariff contract, in a way that can be described by a Nash Bargaining Solution. The chapter compares the effect of different types of mergers on the merged parties' bargaining strength. The results point to the size of the merged entity being a misleading proxy for its buyer power and suggest that using a modified version of Shapiro's diversion ratios, which are termed "buyer diversion ratios", is a better way to analyse the buyer power implications of mergers between retailers. Finally, chapter 6 concludes considering the main results of the thesis in terms both of economic theory and competition policy. The chapter also discusses the limitations of this thesis and identifies areas were the research could be taken forward.