Retail Competition and the Dynamics of Consumer Demand for Tied Goods

38 Pages Posted: 17 Jan 2008 Last revised: 1 May 2012

Wesley R. Hartmann

Stanford University - Graduate School of Business

Harikesh Nair

Stanford University - Graduate School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: May 11, 2009

Abstract

We empirically investigate the demand for tied goods sold through competing retail channels. Tied good pricing strategies commonly involve a low price on the initial purchase (i.e. the primary good) to drive adoption, and a substantial markup on aftermarket goods to capture value. However, if the goods are sold through downstream channels, retail market power and a misalignment of incentives could distort the relative prices of primary and aftermarket goods. To evaluate whether retail competition is strong enough to prevent such distortions, we explore the commonly noted example of razors and blades, which are sold through drug, grocery, mass merchandising, and club stores. We specify a forward-looking demand model that incorporates dynamics arising from the tied good nature of the products and the stockpiling and durability aspects of razors and blades. Furthermore, we allow intertemporal substitution in the purchase of both razors and blades to occur across channels as well as time. This modeling feature enables a novel approach to measuring retail competition in single category demand analyses. Our estimates indicate that there is substantial cross-channel substitution in razors, but some retail market power in blades. However, the channel with the most market power in blades, club stores, specializes in high volume customers that would adopt a razor even if blade prices are higher. This suggests that the manufacturer can achieve its desired level of razor adoption without vertical restraints, though blade sales may be slightly reduced by double marginalization.

Keywords: tied goods, retail competition, dynamic discrete choice models, long-run effects, vertical channels, razor-blade market

JEL Classification: C25, C61, D91, L11, L12, L16, L68, M31

Suggested Citation

Hartmann, Wesley R. and Nair, Harikesh, Retail Competition and the Dynamics of Consumer Demand for Tied Goods (May 11, 2009). Available at SSRN: https://ssrn.com/abstract=1085009 or http://dx.doi.org/10.2139/ssrn.1085009

Wesley R. Hartmann

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Harikesh Nair (Contact Author)

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-736-4256 (Phone)

HOME PAGE: http://faculty-gsb.stanford.edu/nair/index.html

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