Thursday, March 7, 2013
Posted by D. Daniel Sokol
Nicholas Li (Bank of Canada) and Gee Hee Hong (University of Toronto) discuss Market Structure and Cost Pass-Through in Retail.
ABSTRACT: We examine the extent to which vertical and horizontal market structure can together explain incomplete pass-through. We develop a model that highlights the interactions between horizontal and vertical structure and their effects on pass-through from commodity to wholesale prices and wholesale to retail prices. Using scanner data from a large U.S. retailer, we estimate product level pass-through rates for three different vertical structures: national brands, private label goods not manufactured by the retailer and private label goods manufactured by the retailer. We find that greater control of the value chain by the retailer results in higher commodity price pass-through into retail prices compared to national brands 40% higher for private label manufactured goods and 10% higher for private label non-manufactured goods. We also find substantial effects of horizontal structure on pass-through products and brands with higher market shares have higher retail markups and lower cost pass-through. Our results emphasize that accounting for both vertical and horizontal structure is important for understanding how market structure affects pass-through, as a reduction in double-marginalization can raise pass-through directly but can also reduce it indirectly by increasing market share.