Strategic pricing analysis in a vertical sector

The purpose of the research in this thesis is to investigate pricing and firm behavior in the U.S. butter manufacturing and retailing sectors. We develop a new methodology for empirically analyzing vertically and horizontal strategic interactions in a multi-level supply channel. The research innovates by overcoming some of the problematic tractability concerns present in existing multi-level channel studies. It uses a nonlinear Almost Ideal Demand System (AIDS), and the model is flexible enough to consider multi-retailer and multi-manufacturer cases. Like several previously developed channel approaches (e.g. Sudhir 2001), it does not require wholesale price information. The model is applied to the vertically aligned U.S. butter retail and manufacturing sectors. In advance of the estimation stage, a series of preliminary and explorative statistical analyses are conducted to provide important market information about the U.S. butter market. By including only markets with relatively similar pricing structures, we were able to use a much simpler econometric model that yielded sound results. The model was applied across seven geographic markets all in the Midwest region of the U.S. The empirical analysis in this study makes use of Information Resource Inc. (IRI) scanner data for the markets from January 1998 to June 2002.We examine some of the central assumptions commonly used in the literature on vertical relationships. Market structure and strategic pricing are then investigated under best fit assumptions. The system is estimated across a menu of alternative pricing models using (FIML).This finding suggests that previous studies that assume Manufacturer Stackelberg or proportional mark-up pricing behavior by retailers may not be appropriate. The market demand for butter was found to be very price sensitive, and demand for private labels and national brands has high cross price sensitivity. To our knowledge, this is the first structural analysis of the U.S. butter market that considers both vertical and horizontal strategic interactions. Useful measures of imperfect competition in the U.S. butter retailing and manufacturing sectors are reported and discussed.