Management Science, Forthcoming
31 Pages Posted: 7 Mar 2014 Last revised: 22 Aug 2015
Date Written: August 21, 2015
This paper studies a merger between price-setting newsvendors in an oligopolistic market. It is well-known that inventory pooling can greatly reduce inventory costs in a centralized distribution system because it helps reduce aggregate demand uncertainty. Although such statistical economies of scale are important benefits of a retail merger, the extant literature models cost savings from a merger only through reduction in a post-merger firm's marginal cost. In this paper, we develop a model of a retail merger under uncertain demand that distinguishes between cost savings from conventional economies of scale and those from statistical economies of scale, and we show that these two sources of cost savings have substantially different impacts on firms' decisions in a post-merger market. Contrary to the existing theory of mergers developed under deterministic demand, we find that although inventory pooling enables the post-merger firm to achieve cost savings, it always induces firms to raise their prices, and that marginal cost reduction induces firms to lower their prices only when it is substantial - consequently, larger cost synergies can benefit even nonparticipant firms. Finally, even if a merger induces all firms to raise their prices, it can still improve expected consumer welfare by increasing firms' service levels under uncertain demand.
Keywords: Price competition, demand uncertainty, horizontal merger, inventory pooling
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