A Larger Slice or a Larger Pie? An Empirical Investigation of Bargaining Power in the Distribution Channel

Abstract

This research aims to provide insights into the determinants of channel profitability and the relative power in the channel by considering consumer demand and the interactions between manufacturers and retailers in an equilibrium model. We use the Nash bargaining solution to determine wholesale prices and thus how margins are split in the channel. Equilibrium margins are a function of demand primitives and of retailer and manufacturer bargaining power. Bargaining power is itself a function of exogenous retail and manufacturer characteristics. The parties' bargaining positions are determined endogenously from the estimated substitution patterns on the demand side. The more they have to lose in a negotiation relative to an outside option, the weaker the bargaining position.

We use the proposed bargaining model to investigate the role of the three main factors that have been blamed for the power shift from manufacturers to retailers in recent years (firm size increases, store brand introductions, and service level differentiation). In our empirical analysis of the German market for coffee, we find that bargaining power varies among the different manufacturer retailer pairs. This result suggests that bargaining power is not an inherent characteristic of a firm but rather depends on the negotiation partner. We are able to confirm empirically previous theoretical findings that there can be cases where the slice of the pie that goes to one of the channel members may decrease but the overall pie increases and compensates for the smaller share of profits.

Keywords: bargaining, competitive strategy, Distribution, econometric models, industrial organization, marketing strategy