Strategic Pricing Behavior of Channel Members Before and After the Horizontal Merger Between Manufacturers

Abstract

In this research, I study the interactions between several manufacturers and one common retailer, focusing on their pricing behavior. Particularly, I try to uncover the nature of the retailer-manufacturer interaction before and after a horizontal merger between two manufacturers in the toilet tissue market. I take a new empirical industrial organization approach, specifying consumer and firm behaviors and using the notion of equilibrium. For the demand side, I apply the random coefficient logit model. The estimation strategy uses simulation and contraction mapping suggested by Berry, Levinsohn, and Pakes (1995). While they estimated demand and cost equations simultaneously, I follow a two-step approach suggested by Chintagunta, Bonfrer, and Song (2002). For the supply side, using the estimate results obtained from the demand equation, I recover price-cost margins and estimate cost parameters under three different games―vertical Nash, manufacturer Stackelberg, and retailer Stackelberg―to determine which game fits the data best. Additionally, I introduce a conduct parameter in the model in case the three discrete games are not sufficient to capture a wide enough range of possible interactions. As a result of the nonnested hypothesis test, the conduct parameter model fits the data best. By examining the change in the value of conduct parameters, I find that the merging firm became tougher in its pricing. This implies that the manufacturer priced more competitively trying to increase its price-cost margin. Conversely, the manufacturer whose market share was the lowest behaved in a more accommodating manner toward the retailer resulting in the manufacturer's lower price-cost margin than before the merger. The results suggest that the retailer-manufacturer interaction is heterogeneous across manufacturers. This research shows that channel members are interacting with one another and they devise different strategies depending on the market structure they are confronting.