Bargaining in the Supply Chain

Nash bargaining models are increasingly being used in studies of vertical channel pricing, but these models allow for bargaining only over wholesale prices. Drawing on empirical, theoretical, and anecdotal evidence, I propose a new model of bargaining in the vertical channel in which firms negotiate bilaterally over both wholesale and retail prices. I derive equilibrium properties and statics of this model under various demand assumptions, comparing conclusions from this model with those from the wholesale-only bargaining model. I show that retail-and-wholesale price bargaining is more profitable for firms and leads to lower equilibrium retail prices under product symmetry. These results imply that a high degree of channel coordination is widespread as it is in firms' interest to do so, and that a vertical merger under these conditions would lead to fewer efficiencies than under wholesale-only bargaining. As a result, antitrust authorities should take care to use an appropriate model of vertical channel bargaining when analyzing vertical mergers. As an empirical application, I use my model to estimate the effect of private label products on pricing in vertical (manufacturer-retailer) relationships in the US domestic wine industry. I show that wholesale prices and bargaining parameters can be identified using data on prices from states in which the sale of wine is controlled by the state. I use the estimated model to study how retailers use private label products to improve their bargaining position with manufacturers, and I find that offering private label products significantly increases retailers' profit from national brands compared with a no-private label scenario. I compare the conclusions from my model with those of other prominent models of the vertical channel and show that my model better fits the data, which confirms the prediction that firms are more likely to use this bargaining protocol.