Agency Pricing and Bargaining: Evidence from the E-Book Market

Abstract

This paper examines the relationship between agency contracts and retail prices when vertical contracts are determined through bargaining. Our model shows that whether agency contracts lead to higher or lower retail prices than traditional wholesale contracts depends on the distribution of bargaining power across upstream and downstream firms. We propose a methodology to structurally estimate a demand and supply model that allows for both vertical contracting models, and uses the Nash-in-Nash bargaining solution to capture competition between upstream and downstream firms. We estimate our model using data from the market for e-books, which is an industry that has experienced several transitions between agency and wholesale contracts. We analyze the latest switch from wholesale to agency after the expiration of a two-year ban on agency pricing following a lawsuit by the US Department of Justice against major publishers in the industry. This ban allowed us to observe the results of a switch to agency contracts after a rarely seen widespread restart of firm’s bilateral bargaining over vertical contracts. Using a unique dataset of e-book prices both before and after this recent change in selling method, we show that prices went up substantially at Amazon following the shift but remained relatively flat at Barnes & Noble. Structural estimates of the bargaining model show that our bargaining model gives a better fit to the data than a model with take-it-or-leave-it input contracts. Counterfactual simulations indicate that reinstitution of most favored nation clauses, which were banned in 2012 for a period of five years, would lead to price increases of close to nine percent for non-fiction books.

Keywords: e-books, agency agreements, vertical restraints, bargaining

JEL Classification: C14, D83, L13