Vertical Contracts between Manufacturers and Retailers: Inference with Limited Data

Abstract

This paper tests different models of vertical contracting between manufacturers and retailers in the supermarket industry. I estimate demand and use the estimates to compute price-cost margins for retailers and manufacturers under different supply models without observing wholesale prices. I then test which sets of margins seems to be compatible with the margins obtained from direct estimates of cost and select the best among the non-nested competing models. The models considered are: (1) a simple linear pricing model; (2) a vertically integrated model; and (3) a variety of alternative (strategic) supply scenarios, allowing for collusion, non-linear pricing and strategic behavior with respect to private label products. Using data on yogurt sold at several stores in a large urban area of the United States, I find that wholesale prices are close to marginal cost and that retailers have pricing power in the vertical chain. This is consistent with non-linear pricing by the manufacturers or with high bargaining power of the retailers.

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