Buying power and strategic interactionsCan ErutkuCompetition Policy Branch, Competition BureauAbstract. This paper shows that buying power at the retail level can lead to a rise in wholesale price. As a result, retailers without buying power may increase their retail price. Nevertheless, total surplus is non-decreasing in the degree of buying power possessed by the dominant retailer. JEL classification: L13Pouvoir dachat et interactions strategiques. Ce me moire montre que le pouvoir dachat au niveau du commerce de de tail peut mener a un accroissement dans les prix de gros. En conse quence, les de taillants qui nont pas de pouvoir dachat peuvent accrotre leurs prix au de tail. Ne anmoins, le surplus total ne de crot pas a mesure que le degre de pouvoir dachat du de taillant saccrot.1. IntroductionRecently, countervailing power or buying power has received considerable attention in the economic literature. For instance, Ungern-Sternberg (1996) and Dobson and Waterson (1997) look at how an increase in concentration at the retail level leads to an increase in buying power for all firms. As consolida- tion takes place at the retail level, the bargaining position of each retailer is improved, since the supplier faces fewer alternatives to sell its product.1 Simultaneously, an increase in concentration at the retail level leads to more market power for retailers when selling to customers. Hence, it is difficult to identify the effect of an increase in buying power alone on retail prices, since the price changes are a consequence of both the increase in buying power and market power in retailing. For example, retail prices go up if the market powerIwouldliketothankZhiqiChen,AidanHollis,andtwoanonymousrefereesfortheirvaluableand insightful comments and suggestions. I am solely responsible for all remaining errors. The views expressed here are solely those of the author and are not purported to be those of the Competition Bureau or of the Commissioner of Competition. Email: erutku.canbc-cb.gc.ca 1 Both authors use the Nash bargaining solution to solve the negotiations between the supplier and retailers over the wholesale price. While retail competition is in quantity in Ungern-Sternberg (1996), it is in price with differentiated products in Dobson that is, when competition at retail is intense and involves homogeneous products, our results converge to those obtained by Chen (2003): the wholesale price and retail prices are decreasing in the degree of buying power. Finally, because firms are not symmetric with respect to retailing costs, Chen (2003) finds that total surplus might be increasing or decreasing depending on the market share of the dominant retailer and the size of cost asymmetries between the dominant firm and the fringe.3In our model, no retailing cost asymmetries are introduced, and we obtain that total surplus is non-decreasing in the degree of buyer power because of its effect on retail prices. Section 2 presents the model where we suppose that the national retailer can obtain a discount from the supplier over the wholesale price. Section 3 presents the results. Finally, Section 4 concludes.2. The modelSuppose m 1 local markets, where a national retailer is competing with a local retailer. In each of the m retail markets, the demand side is described by the preferences of a representative end-consumer over the set of available products. These preferences are represented by the following utility function:UqN;qL ?qN qL ? 1=2 q2N q2 L 2?qNqL? x:1In equation (1), ? 0 measures the size of the market; x denotes a composite commodity; and qNand qLdenote the quantity purchased of the national retailer good and the local retailer good, respectively. The parameter ? 2 (0, 1) is an indicator of the degree of substitutability between the national retailer3 In his model, fringe retailers are more efficient at small scale, but the dominant retailer is more efficient at large scale.1162C. Erutkuand the local retailer. If ? 0, retailers are independent; if 0 0 and ?(1 ? ?) ? pL ?pN 0.Buying power and strategic interactions1163(1 ? ?2)q2i. Retailers equilibrium prices and quantities in each of the m mar- kets are then given bypN1 ? ?2 ? 2w1 ? ? ?w 4 ? ?23pL1 ? ?2 ? 2w ?w1 ? ? 4 ? ?24qN1 ? ?2 ? ? w2 ? ?21 ? ? ? ? 4 ? ?21 ? ?25qL1 ? ?2 ? ? w2 ? ?2 ? ?1 ? ? 4 ? ?21 ? ?2:6In stage 1, the supplier chooses its wholesale price w to maximize its profit ?S (1 ? ?)wqN wqL. Defining ? and ? as? 1 ? ?2 ? 2 ? 2 ? ?21 ? ?2 2 ? ?2 ? 2?1 ? ?;we obtain that whenever both retailers in a local market remain active; that is, whenever(2 ? ?2)(2 ? 3? 2?2) ? ?(2 ? ? ? ?2) 0,theequilibrium wholesale price, retail prices, and quantities in each of the m markets arew*?;? ?2 ? ? ?7p*N?;? ? 4 ? ?2? f2 21 ? ? ?2 ? ?=?g8p*L?;? ? 4 ? ?2? f2 2 ?1 ? ?2 ?