\section{Motivation}

It is the exception rather than the rule that manufacturers sell directly to
final consumers. Instead, consumers and manufacturers mostly interact
through intermediaries such as retailers. When the retail sector was highly
fragmented and not very differentiated, the retail industry constituted a
\textquotedblleft transparent\textquotedblright\ window between suppliers
and consumers. This perception has changed dramatically in the last couple
of decades. Due to internal growth and mergers by leading retailers, the
retail industry has become increasingly consolidated. Additionally, new
store formats have emerged and more and more large retail chains have
prevailed. As a consequence a limited number of large-scale retailers have
obtained market dominance, while small independent retailers have been
driven out of the market. Meanwhile, the typical production structure
corresponds to a vertical chain, where both buyers and sellers have some
degree of market power. This pattern of development has been common all over
Europe, whereas among all areas of retailing, it is food retailing that has
passed through the most profound changes (EU,\ 1999, Dobson et al., 2001).
The further illustration, therefore, relies on the recent developments in
food retailing.

In the EU-15 retail concentration has been increasing during the last few
decades (see Table 1). The weighted average of the concentration ratio of
the top-five retailers (CR 5) increased by more than 20 percentage points
between 1993 and 2002 such that the CR 5 in most of the EU\ member states
accounts for over 50\%. The only exception is Italy, where the top-five
retailers accounted for not more than 37\% of sales in grocery and daily
goods retailing in 2002. This is due to the fact that in Italy even larger
retailers constitute cooperatives which are at least locally embedded (Potz,
2002). In Sweden, retail concentration is the highest in Europe with a CR\ 5
of 94.7\% in 2002. The strongest consolidation process between 1993 and 2002
was experienced by Greece, where the CR 5 increased from 10.9\% to 52.7\%.
Interestingly, the consolidation of German food retailing resembles more or
less the European average.

Although all European countries experienced similar patterns of
consolidation, differences have occurred with respect to the emergence of
retail formats. In particular, discount stores as well as hypermarket
formats play an important role in food retailing, whereas the latter is
characterized by a sales area of more than 1,500 m$^{2}$. For example,
Germany has seen the expansion of both format types. In 2005 the discounters
increased their aggregate market share by 1.5 percentage points up to 24.5\%
and hypermarkets increased their market share by 0.5 percentage points. To
the contrary, the market share of smaller retail formats with less than 800 m%
$^{2}$ reduced by 2 percentage points. Similarly, the UK and France have
seen a notable increase of large-scale retail outlets and a decline in
traditional retailing.

This development has been favored by the recent trend in consumer behavior
towards one-stop shopping. Due to the increase in both the requirements in
professional life and the estimation of spare-time activities, time has
become more and more scarce. Through this growing opportunity costs of time
favor the economization of shopping time (Carlson and Giesieke, 1983),
followed by an increasing tendency towards one-stop shopping in consumers'
behavior. That is, consumers prefer to bundle their purchases (Dellaert et
al., 1998) in order to reduce their shopping costs instead of wasting their
time by shopping at different stores. By bundling their demand for goods
from different categories and by reducing their shopping trips to a
main-trip which they then complete with smaller top-up trips in a particular
period of time, consumers realize economies of scope and economies of scale.
According to a survey by the UK\ Competition Commission (2000), about 70\%
of consumers evince one-stop shopping behavior in spending about 80\% of
their weekly expenditures on fast-moving consumer goods on a weekly main
trip. This reduces the frequency of shopping trips, while the volume per
trip increases. As a consequence, competition among retailers has become
fiercer (Matutes and Regibeau, 1988).

However, the structural changes towards large-scale retail outlets are
limited by quite severe planning restrictions all over Europe. In contrast
to most of the other fields of retail regulation, the liberalization effort
is relatively low in this area. In Italy, market entry of retailers was
restricted by a public license system enacted in 1926 and a town-planning
act from 1942 in order to secure the fragmented retail structure. This
system was amended in 1971 in order to facilitate the market entry of larger
retail outlets. Hence, since 1971, retailers with sales areas over 1,500 m$%
^{2}$ required a Regional Authority permission, while retailers over 400 m$%
^{2}$ only required a local municipality permission. However, the license
and permission system has been abolished by the Bersani-Amendment in 1998,
whereas there are still planning restrictions. In contrast to the shopping
hours, there is no tendency to liberalize the planning restrictions in
Germany. That is, retailers with sales areas over 800 m$^{2}$ are limited in
their location choice; they are only allowed to settle down in particular
areas called \textquotedblleft Kern- und Sondergebiete\textquotedblright\ in
order to reduce their negative impact on town planning and traffic in
residential areas. These severe restrictions could be the reason for the
extreme expansion of discount stores in Germany as they typically cover
about 400 m$^{2}$. Although retailing in the UK is less restricted than in
most other European countries, stricter planning rules were introduced in
1988 for the first time in order to countervail the trend towards the
increasing importance of large-scale retailers. According to the revised
Planning Policy Guidance Note 6 (PPG\ 6) of 1996, the planning of a new
supermarket outlet in terms of location requires a sequential procedure.
That is, town centers have to be preferred vis-\`{a}-vis edge-of-town areas.
On the one hand, this rule softens the competition at the edge of the town,
and, on the other hands, it limits the further expansion of hypermarkets
since large sales areas in town centers are relatively rare and,
furthermore, construction in town centers has to consider several
restraints. While the effort to liberalize planning restrictions is
relatively low, in most European countries a great deal of effort has been
undertaken in order to soften other fields of regulation. Overall, it can be
concluded that the scope of retailers has been enlarged during the last
couple of years such that they have more possibilities to differentiate
their businesses.

Finally, the scope of retailers has increased during the last couple of
years. In addition to the location where consumers make their purchases,
retailers increasingly provide additional services to consumers by investing
in physical, ambient and social features of the in-store environment or by
marketing activities like the provision of services or cash and credit
facilities (Oxford Institute of Retail Management, 2004). This induces a
higher degree of differentiation at the retail level which is further
enhanced by the ongoing liberalization process in European retailing. That
is, regulation particularly restricting retailers' shopping hours has been
relaxed in most European countries. For example, since 1998 Italian
retailers have been allowed to keep their stores open until 10 p.m. on week
days. Similarly, in Germany the regulatory framework with respect to
shopping hours was softened when the L\"{a}nder obtained the responsibility
of shopping hours in the course of the \textquotedblleft Federalism
Reform\textquotedblright\ in 2006. The UK\ was already starting to
deregulate the retail industry in the 1980s. The \textquotedblleft Sunday
Trading Act\textquotedblright\ enacted in 1994 prohibits retail outlets
covering more than 280 square meters to open more than six hours.

Bringing together all the different aspects in the recent development of
retailing such as the ongoing consolidation process, consumers' preference
for one-stop shopping, and the larger scope of retailers, the face of
retailing has changed during the last few decades. As a consequence,
retailers are regarded as \textquotedblleft strategic
gatekeepers\textquotedblright\ rather than competitive distributors of
consumer products. This may enable retailers to exercise market power vis-%
\`{a}-vis suppliers. Retailers' buyer power constitutes, therefore, an
important issue in Europe as indicated by the Green Paper on Vertical
Restraints issued by the European Commission as well as by several reports
of the European Commission and the OECD.

\section{Related Literature}

The welfare effects of buyer power are a priori unclear. In order to
highlight the general insights about sources and consequences of buyer
power, the subsequent section sketches the established theory on vertical
relations and buyer power.

The performance of vertically separated industries depends on various
decision variables. Since independent but vertically related firms do not
internalize the externalities induced by their decisions, coordination
failures may arise. A well-known example constitutes the double
marginalization which results from linear pricing in intermediate good
markets under imperfect competition. As a consequence, joint profits are
lower than they would be if buyer and seller had coordinated their decision
(Cournot, 1838, Spengler, 1950). Furthermore, information asymmetries
between upstream and downstream firms give rise to undesirable horizontal
and vertical externalities. That is, competition between retailers is likely
to generate an insufficient level of services from both the firms' and the
consumers' point of view. For instance, the lack of control for selling
expenses leads to an underprovision of effort and to free-riding. The
literature shows that vertical agreements or contractual provision such as
fixed fees, ties, exclusive dealing, exclusive territories or resale price
maintenance, serve as means to coordinate and restore the efficiency of the
vertical chain. However, the equivalence of vertical restraints vanishes
under uncertainty. Thus, Rey and Tirole (1986)\ show that RPM\ is preferred
to two-part tariffs when demand is uncertain, while the contrary is true
under cost uncertainty.

But no simple conclusion can be derived on whether any particular type of
vertical restraint is welfare enhancing or decreasing. Although downstream
competition mitigates the pure problem of double marginalization, it is not
sufficient to restore maximum profits in the vertical chain. That is,
competition among retailers reduces the retail mark-up, which in turn makes
the retailers choose the consumers' preferred balance between retail price
and level of services. Therefore, the joint profit of the vertical structure
is not maximized which remains valid even if retailers are differentiated
(Spiegel and Yehezkel, 2003). Thus, vertical restraints like exclusive
territories that help to overcome the underprovision of services (Mathewson
and Winter, 1984) are likely to be socially desirable.\ But vertical
restraints can also be used to reduce competition on the upstream market or
to maintain joint-profit-maximizing prices at downstream levels. Rey and
Stiglitz (1988, 1995) show that exclusive territories which eliminate
intra-brand competition within a vertical structure, can help to reduce
inter-brand competition. Jullien and Rey (2007) show that by leading to
more-uniform retail prices, RPM makes price cuts easier to detect, and
therefore RPM facilitates collusion when retailers compete on prices. Thus,
vertical restraints can also prevent competition and support monopolization
such that welfare implications are ambiguous. For a summary of the relevant
literature see Katz (1989) and Rey and Verg\'{e} (2008).

Models considering vertical relationships are often characterized by an
implicit assumption about the distribution of bargaining power. That is, one
party has the possibility to make a take-it-or-leave-it offer to her
bargaining partner (Rey and Tirole, 2007). Formal analysis has therefore
often neglected the strategic role retailers have obtained in the last few
decades. Despite the increasing importance of retailers, the retail industry
has been seen as a \textquotedblleft transparent window\textquotedblright\
to final consumer markets. This approach neglects imperfect competition at
both sides and thus the problem of bilateral bargaining power. That is, with
the emergence of larger buyer and sellers however, it becomes more likely
that buyers and sellers bargain about the terms of contract (Iyer and
Villas-Boas, 2003), whereas negotiations in bilateral oligopolies are
increasingly important (Bj\"{o}rnerstedt and Stennek, 2001, Inderst and Wey,
2003).

The formalization of buyer power in such a bargaining framework differs from
the textbook view where buyer power is modeled as monopsony. In the
monopsony framework, wholesale prices are increasing in buyers' demand.
Accordingly, withholding demand leads to lower wholesale prices. In
bilateral oligopolies, however, sources and consequences of buyer power are
less obvious. The recent literature on retailers' buyer power in vertically
related markets builds therefore on tools of modern bargaining theory such
as non-cooperative multilateral bargaining. Some papers model negotiations
as simultaneous and separate (see for example Hart and Tirole, 1990, McAfee
and Schwartz, 1994). In that case, the bargaining outcome is assumed not to
be contingent on whether or not negotiations of rival pairs are successful
(Rey and Verg\'{e}, 2004). In contrast, Inderst and Wey (2003) or de
Fontenay and Gans (2005) postulate that the contract terms of a bargaining
pair are contingent on a rival pair's disagreement. The assumption captures
the idea that a negotiation breakdown is permanent and irrevocable, and
therefore common knowledge.

The recent literature on buyer power advances some interesting explanations
as to why larger retailers may have greater buyer power. Size may increase
the retailer's buyer power by raising the value of his own outside option.
If a buyer is large enough, she can credibly threaten to integrate
backwards, thereby rendering the supplier redundant (Katz, 1987, Sheffman
and Spiller, 1992). Similarly, large buyers are able to introduce
competition in upstream markets by establishing a private label (Fumagalli
and Motta, 2006). Larger buyer power also emerges as a consequence of
reducing the supplier's outside option. According to Inderst and Wey (2007a)
when bargaining breaks down with a large buyer, the supplier finds it
difficult to unload the cancelled demand onto the remaining buyers as this
involves \textquotedblleft marching down\textquotedblright\ the declining
marginal surplus functions. Chipty and Snyder (1999) and Raskovich (2003)
assume that buyers negotiate with a monopoly supplier. If the aggregate
surplus function across all negotiations is concave in quantity, the
incremental surplus increases more than proportionally in buyer size, which
explains why large buyers pay a lower price per unit. Considering competing
suppliers instead, Snyder (1996, 1998) shows that supplier collusion is
difficult to sustain in the presence of large buyers, because such buyers
are more likely to tempt an individual supplier to deviate from the
collusive strategy. To understand this effect, note that the larger the
buyer, the more a supplier can win if she deviates. To prevent undercutting
in equilibrium, suppliers have to collude on lower prices for large buyers.
A further key determinant of buyer power is the number of goods that an
outlet stocks. After a merger or the formation of a buyers' alliance the new
entity may announce that it will no longer stock the goods of all previous
suppliers which increases the intensity of upstream competition (Dana, 2006,
Inderst and Shaffer, 2007). Turning to the relation between buyer power and
the suppliers' incentives to innovate, it is often suggested that the
exercise of buyer power could stifle suppliers' incentives to invest and
innovate (FTC, 2001). This supposition has been qualified by Inderst and Wey
(2003, 2007a, b) who argue that buyer power tends to increase suppliers'
incentives at the margin. (Battigalli et al., 2007) show that increasing
retailer competition reduces suppliers' investments. Inderst and Mazzarotto
(2006) synthesize the literature on buyer power and emphasize that typically
both seller and buyer power coexist. Furthermore, considering the different
effects buyer power can have on negotiations and contractual agreements, the
welfare consequences of buyer power are in general ambiguous. However, there
are several arguments that show procompetitive effects of buyer power such
that consumers more often than not benefit while suppliers (and smaller
retailers) are hurt (a typical conflict associated with buyer power).

\section{Objectives and Main Results}

Against this background, my thesis aims at extending the current literature
on industrial organization in vertically related industries. Specifically, I
focus on how vertical relations are affected by buyer power of downstream
industries. Using a non-cooperative bargaining approach for modeling
negotiations in intermediate good markets, I analyze the relations between
upstream suppliers and downstream buyers. More precisely, I address the
question of how consumers' one-stop shopping behavior influences strategic
considerations of upstream suppliers if wholesale prices are negotiated in
intermediate good markets. I also explain the use of below-cost pricing and
slotting allowances by downstream retailers. I assess the welfare
implications of these retail strategies and examine how they affect the
distribution of rents along the value chain. By this, I contribute to the
current debates on competition policy by confronting my theoretical results
with competition policy practices. Following my general aims, my thesis is
divided into three parts referring to the impact of one-stop shopping on
upstream merger incentives, the assessment of below-cost pricing as well as
the role of retailer's assortment decision on negotiations in intermediate
good markets.

In Chapter 2, which is a joint work with Christian Wey, the impact of
consumers' one-stop shopping behavior on upstream merger incentives is
analyzed. It is conventional wisdom that shopping costs induce consumers to
bundle their purchases. This leads to complementarities in the market
demand, even if the goods included in the consumers' shopping basket are
substitutes or independent goods from a consumption point of view (Holton,
1957, Beggs, 1994). There are only a few results concerning the distinction
between complements or substitutes in vertical structures. A notable
exception is Horn and Wolinsky (1988a) who show that complementary of
products gives rise to incentives to stay independent in order to extract
more rents from a common retailer. This result is also obtained by Horn and
Wolinsky (1988b) for the case of competing supply chains when input prices
are linear. Besides these contributions, the exact modeling of one-stop
-shopping behavior and the analysis of its impact on vertical relations is
still largely unexplored. We examine the merger incentives of two suppliers
selling consumer goods to a common retailer when wholesale prices are
bilaterally negotiated and a share of consumers prefers one-stop shopping.
We show that an upstream merger becomes more likely if the share of one-stop
shoppers increases and retailer's bargaining power is sufficiently low. Our
findings provide a new mechanism through which increasing buyer power may
have adverse effects on social welfare, as buyer power makes desirable
supplier mergers less likely. But we also show that a retailer has
incentives to take actions in favor of one-stop shoppers in order to trigger
an upstream merger which is beneficial to both the retailer and consumers.
This may even lead to excessive investments by the retailer. Our results
have strong implications for competition policy and merger control, in
particular. Until now mergers between competitors in relatively concentrated
markets have been forbidden if they do not imply synergies. However, we show
that mergers may unfold positive effects as they help to internalize the
adverse pricing externalities usually associated with the pricing of
complements. This in turn implies a reduction of the double marginalization
which is always socially beneficial.

In Chapter 3, I analyze the use of below-cost pricing by retailers and
examine its impact on social welfare as well as on suppliers' incentives to
invest in quality. Currently, there is a strong debate on whether below-cost
pricing is driven by the intention to exclude competitors or not. In a
vertical setting, representatives of the agricultural sector and consumer
protectors assess sales at a loss as a means for squeezing wholesale prices
and jeopardizing quality assurance. Considering negotiations on a linear
wholesale price between one retailer and several upstream manufacturers and
assuming one-stop shopping behavior of consumers, I find that the retailer
sells those goods at a loss which are bought by almost all consumers and
whose reserve price is sufficiently low. My results show further that
loss-leader prices are more likely at discount stores while they are less
likely at hypermarkets or specialized retailers. With respect to the
distribution of rents along the value chain, I point out that both the
retailer and consumers lose, while the supplier always gains if her good is
sold below-cost. These results are driven by the bargaining process in
intermediate good markets. That is, potential sales at a loss in downstream
markets improve the supplier's bargaining position vis-\`{a}-vis the
retailer since the supplier's marginal contribution to the joint profit with
the retailer increases if the retailer uses her good in order to attract
consumers. Correspondingly, wholesale prices are increasing as a result of
below-cost pricing in final consumer markets. This strengthens the double
marginalization in the vertical chain and thus leads to welfare losses. With
respect to dynamic efficiency, I find that suppliers have higher incentives
to invest in high-quality products if a ban on below-cost pricing is
enforced.

Finally, the use of the retailer's assortment decision for strengthening her
bargaining position vis-\`{a}-vis suppliers is examined in Chapter 4, which
is a joint work with Pio Baake. Despite the growing sales areas in the
retail industry, retail shelf space is still limited. For example, the
German food industry offers about 150,000 products to retailers whose
assortment consists merely of 6,200 to 30,000 products on average. For
discounters the number of offered goods is even lower at 600 to 1,900 goods.
Similar data for the U.S. is quoted by Shaffer (2005). Together with
consumers' preferences for one-stop shopping, the limited shelf space turns
retailers into essential intermediaries between manufacturers and consumers
and gives them gatekeeper control to final consumer markets. Retailers are,
therefore, in a position to ask their suppliers to make upfront payments in
order to get access to final consumer markets. This, in turn, raises strong
debates on their competitive effects and have been the focus of recent
antitrust studies (FTC\ 2001, 2003). Based on the analysis of negotiations
between suppliers and retailers, we provide a theory of retailer's
assortment decision and show how the variety of offered goods at retail
outlets is affected by the bargaining processes in intermediary goods
markets. Furthermore, we explain the occurrence of slotting allowances and
examine their impact on the retailer's listing decision. We consider a
sequential game with upfront payments being negotiated before short-term
delivery contracts. We show that the retailer is more likely to use upfront
payments the higher her bargaining power and the higher the number of
potential suppliers. Furthermore, we find that upfront payments tend to
lower the number of products offered by the retailer when products are
rather close substitutes. With very low substitutability, however, long-term
contracts increase the number of products offered when the number of
potential suppliers is high. Hence, upfront payments can increase social
welfare if they ameliorate inefficient listing decisions implied by
short-term delivery contracts only.