Upstream Uncertainty and Countervailing Power

Abstract

We study vertical contracting through bargaining between an upstream supplier and downstream retailers. We consider the effect of supplier uncertainty as to final volumes on the efficient bargains struck. Uncertainty causes retail price effects: large buyers wield countervailing power (deliver lower retail prices) if upstream marginal costs are decreasing. If there were no upstream uncertainty, downstream retail prices would be independent of buyer size. With enough uncertainty large buyers have buyer power also (secure advantageous input prices). Downstream mergers, or organic growth of a downstream firm, change the uncertainty facing the upstream supplier and so result in "waterbed effects'' on other buyers. We show that uncertainty for suppliers can be generated by upstream competition.

Keywords: countervailing power, buyer power, waterbed effects, bargaining interface, supply chain uncertainty, supermarkets, vertical contracts

JEL Classification: L14, L42