Measuring the Welfare of Intermediation in Vertical Markets

Donna, Javier D. and Pereira, Pedro and Pires, Tiago and Trindade, Andre (2018): Measuring the Welfare of Intermediation in Vertical Markets.

Abstract

We empirically investigate the welfare implications of intermediaries in oligopolistic markets, where intermediaries offer additional services to differentiate their products from the ones of the manufacturers. Our identification strategy exploits the unique circumstance that, in the outdoors advertising industry, there are two distribution channels: consumers can purchase the product either directly from manufacturers, or through intermediaries. We specify a differentiated products’ equilibrium model, and estimate it using product-level data for the whole industry. On the demand side, the model includes consumers who engage in costly search with preferences that are specific to the distribution channel. On the supply side, the model includes two competing distribution channels. One features two layers of activity, where manufacturers and intermediaries bargain over wholesale prices, and intermediaries compete on final prices to consumers. The other is vertically integrated. The estimated model is used to simulate counterfactual scenarios, where intermediaries do not offer additional services. We find that the presence of intermediaries increases welfare because the value of their services outweighs the additional margin charged.

• Item Type: MPRA Paper
• English Title: We empirically investigate the welfare implications of intermediaries in oligopolistic markets, where intermediaries offer additional services to differentiate their products from the ones of the manufacturers. Our identification strategy exploits the unique circumstance that, in the outdoors advertising industry, there are two distribution channels: consumers can purchase the product either directly from manufacturers, or through intermediaries. We specify a differentiated products’ equilibrium model, and estimate it using product-level data for the whole industry. On the demand side, the model includes consumers who engage in costly search with preferences that are specific to the distribution channel. On the supply side, the model includes two competing distribution channels. One features two layers of activity, where manufacturers and intermediaries bargain over wholesale prices, and intermediaries compete on final prices to consumers. The other is vertically integrated. The estimated model is used to simulate counterfactual scenarios, where intermediaries do not offer additional services. We find that the presence of intermediaries increases welfare because the value of their services outweighs the additional margin charged.
• Language: English
• Keywords: Intermediaries, vertical markets, search frictions, bargaining, outdoor advertising
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness; L - Industrial Organization > L4 - Antitrust Issues and Policies > L42 - Vertical Restraints ; Resale Price Maintenance ; Quantity Discounts; L - Industrial Organization > L8 - Industry Studies: Services > L81 - Retail and Wholesale Trade ; e-Commerce; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M3 - Marketing and Advertising > M37 - Advertising

References

[1] Ahn, J., A. K. Khandelwal, and S.-J. Wei (2011): “The role of intermediaries in facilitating trade,” Journal of International Economics, 84(1), 73–85.

[2] Arie, G., P. L. E. Grieco, and S. Rachmilevitch (2016): “Generalized Insurer Bargaining,” Working Paper.

[3] Armstrong, M. (2006): “Competition in two-sided markets,” The RAND Journal of Economics, 37(3), 668–691.

[4] Baye, M. R., J. Morgan, and P. Scholten (2003): “The value of information in an online consumer electronics market,” Journal of Public Policy & Marketing, 22(1), 17–25.

[5] Baye, M. R., J. Morgan, and P. Scholten (2006): “Information, search, and price dispersion,” Handbook on economics and information systems, 1, 323–77.

[6] Ben-Akiva, M. E., and S. R. Lerman (1985): Discrete Choice Analysis: Theory and Application to Travel Demand, vol. 9. MIT press.

[7] Bernard, C., and B. Jullien (2003): “Chicken and Egg: Competition among Intermediation Service Providers,” RAND Journal of Economics, 34(2), 521.

[8] J. Levinsohn, and A. Pakes (1995): “Automobile prices in market equilibrium,” Econometrica, pp. 841–890.

[9] Berry, S. T. (1994): “Estimating discrete-choice models of product differentiation,” The RAND Journal of Economics, pp. 242–262.

[10] Berry, S. T., and P. A. Haile (2014): “Identification in differentiated products markets using market level data,” Econo- metrica, 82(5), 1749–1797.

[11] Biglaiser, G. (1993): “Middlemen as experts,” The RAND journal of Economics, pp. 212–223.

[12] Biglaiser, G., F. Li, C. Murry, and Y. Zhou (2017): “Middlemen as Information Intermediaries: Evidence from Used Car Markets,” Working Paper.

[13] Boik, A. (2016): “Intermediaries in Two-Sided Markets: An Empirical Analysis of the US Cable Television Industry,” American Economic Journal: Microeconomics, 8(1), 256–282.

[14] Bonnet, C., Z. Bouamra-Mechemache, and H. Molina (2016): “Vertical Relationships in Bilateral Oligopolies: A Structural Bargaining Model with Limited Data,” Working Paper.

[15] Bonnet, C., and P. Dubois (2010): “Inference on vertical contracts between manufacturers and retailers allowing for nonlinear pricing and resale price maintenance,” The RAND Journal of Economics, 41(1), 139–164.

[16] Brenkers, R., and F. Verboven (2006): “Market definition with differentiated products: lessons from the car market,” in Choi, J.P. (Ed.), Recent Developments in Antitrust: Theory and Evidence.

[17] Brown, J. R., and A. Goolsbee (2002): “Does the Internet make markets more competitive? Evidence from the life insurance industry,” Journal of political economy, 110(3), 481–507.

[18] Brunnermeier, M. K., and Y. Sannikov (2014): “A macroeconomic model with a financial sector,” The American Economic Review, 104(2), 379–421.

[19] Brynjolfsson, E., Y. Hu, and M. D. Smith (2003): “Consumer surplus in the digital economy: Estimating the value of increased product variety at online booksellers,” Management Science, 49(11), 1580–1596.

[20] Brynjolfsson, E., and M. D. Smith (2000): “Frictionless commerce? A comparison of Internet and conventional retailers,” Management science, 46(4), 563–585.

[21] Busse, M., and M. Rysman (2005): “Competition and Price Discrimination in Yellow Pages Advertising,” RAND Journal of Economics, pp. 378–390.

[22] Cardell, N. S. (1997): “Variance components structures for the extreme-value and logistic distributions with application to models of heterogeneity,” Econometric Theory, 13(02), 185–213.

[23] Chade, H., and L. Smith (2006): “Simultaneous search,” Econometrica, 74(5), 1293–1307.

[24] Chamberlain, G. (1982): “Multivariate regression models for panel data,” Journal of econometrics, 18(1), 5–46. ?

[25] Chu, C. S., P. Leslie, and A. Sorensen (2011): “Bundle-Size Pricing as an Approximation to Mixed Bundling,” American Economic Review, 101, 263–303.

[26] Ciliberto, F., and J. W. Williams (2014): “Does multimarket contact facilitate tacit collusion? Inference on conduct parameters in the airline industry,” The RAND Journal of Economics, 45(4), 764–791.

[27] Cohen, A. (2008): “Package size and price discrimination in the paper towel market,” International Journal of Industrial Organization, 26(2), 502–516.

[28] Collard-Wexler, A., G. Gowrisankaran, and R. S. Lee (2016): “‘Nash-in-Nash’ Bargaining: A Microfoundation for Applied Work,” NBER Working Paper No. 20641.

[29] Conlon, C. T., and N. Rao (2015): “The Price of Liquor is Too Damn High: Alcohol Taxation and Market Structure,” Working Paper.

[30] Craig, S., M. Grennan, and A. Swanson (2018): “Mergers and Marginal Costs: New Evidence on Hospital Buyer Power,” Working Paper 24926, National Bureau of Economic Research.

[31] Crawford, G. S., R. S. Lee, M. D. Whinston, and A. Yurukoglu (2018): “The welfare effects of vertical integration in multichannel television markets,” Econometrica, forthcoming. ?

[32] Crawford, G. S., and A. Yurukoglu (2012): “The welfare effects of bundling in multichannel television markets,” The American Economic Review, 102(2), 643–685.

[33] De los Santos, B., A. Hortaçsu, and M. R. Wildenbeest (2012): “Testing models of consumer search using data on web browsing and purchasing behavior,” The American Economic Review, 102(6), 2955–2980.

[34] Diamond, D. W. (1984): “Financial intermediation and delegated monitoring,” The Review of Economic Studies, 51(3), 393– 414?

[35] Donna, J., and T. Pires (2016): “Quantity Discounts, Price Discrimination, and Incentive Compatibility Constraints,” Working Paper, The Ohio State University Discussion Papers.

[36] Draganska, M., D. Klapper, and S. B. Villas-Boas (2010): “A larger slice or a larger pie? An empirical investigation of bargaining power in the distribution channel,” Marketing Science, 29(1), 57–74.

[37] Dubois, P., and M. Sæthre (2016): “On the Role of Parallel Trade on Manufacturers and Retailers Profits in the Pharmaceutical Sector,” Working Paper.

[38] Edelman, B., and J. Wright (2015): “Price coherence and excessive intermediation,” The Quarterly Journal of Economics.

[39] Ellison, G., and S. F. Ellison (2009): “Search, obfuscation, and price elasticities on the internet,” Econometrica, 77(2), 427–452.

[40] Ershov, D. (2018): “The effect of consumer search costs on entry and quality in the mobile app market,” Discussion paper, Mimeo.

[41] Evans, D. S. (2003): “The antitrust economics of multi-sided platform markets,” Yale J. on Reg., 20, 325.

[42] Farboodi, M., G. Jarosch, and G. Menzio (2017): “Intermediation as Rent Extraction,” NBER Working Paper No. 24171.

[43] Frakt, A. (2017): “Why the CVS-Aetna Merger Could Benefit Consumers.,” The New York Times, Dec. 3, 2017.

[44] Frankel, J. A., G. Galli, and A. Giovannini (2009): The microstructure of foreign exchange markets. University of Chicago Press.

[45] Freixas, X., and J.-C. Rochet (2008): Microeconomics of banking. MIT press.

[46] Fréchette, G. R., A. Lizzeri, and T. Salz (2018): “Frictions in a Competitive, Regulated Market: Evidence from Taxis,” Working Paper 24921, National Bureau of Economic Research.

[47] Galeotti, A., and J. L. Moraga-González (2009): “Platform intermediation in a market for differentiated products,” European Economic Review, 53(4), 417–428.

[48] Gandhi, A., and J.-F. Houde (2016): “Measuring substitution patterns in differentiated products industries,” Working Paper.

[49] Gavazza, A. (2016): “An empirical equilibrium model of a decentralized asset market,” Econometrica, 84(5), 1755–1798.

[50] Gehrig, T. (1993): “Intermediation in search markets,” Journal of Economics & Management Strategy, 2(1), 97–120.

[51] Goeree, M. S. (2008): “Limited information and advertising in the US personal computer industry,” Econometrica, 76(5), 1017–1074.

[52] Gowrisankaran, G., A. Nevo, and R. Town (2015): “Mergers when prices are negotiated: Evidence from the hospital industry,” American Economic Review, 105(1), 172–203.

[53] Grennan, M. (2013): “Price discrimination and bargaining: Empirical evidence from medical devices,” The American Economic Review, 103(1), 145–177.

[54] Grigolon, L., and F. Verboven (2014): “Nested logit or random coefficients logit? A comparison of alternative discrete choice models of product differentiation,” Review of Economics and Statistics, 96(5), 916–935.

[55] Haan, M., and J. L. Moraga-González (2011): “Consumer Search with Observable and Hidden Characteristics,” Working Paper.

[56] Hagiu, A., and B. Jullien (2011): “Why do intermediaries divert search?,” The RAND Journal of Economics, 42(2), 337–362.

[57] Hansen, L. P. (1982): “Large sample properties of generalized method of moments estimators,” Econometrica, pp. 1029–1054.

[58] Hauser, J. R., and B. Wernerfelt (1990): “An evaluation cost model of consideration sets,” Journal of consumer research, 16(4), 393–408.

[59] Hausman, J. A. (1996): “Valuation of new goods under perfect and imperfect competition,” in The economics of new goods, pp. 207–248. University of Chicago Press.

[60] He, Z., and A. Krishnamurthy (2013): “Intermediary asset pricing,” The American Economic Review, 103(2), 732–770.

[61] Ho, K., and R. S. Lee (2017): “Insurer Competition in Health Care Markets,” Econometrica, 85(2), 379–417.

[62] Honka, E. (2014): “Quantifying search and switching costs in the US auto insurance industry,” The RAND Journal of Economics, 45(4), 847–884.

[63] Horn, H., and A. Wolinsky (1988): “Bilateral monopolies and incentives for merger,” The RAND Journal of Economics, pp. 408–419.

[64] James, C. (1987): “Some evidence on the uniqueness of bank loans,” Journal of financial economics, 19(2), 217–235.

[65] Janssen, M., and S. Shelegia (2015): “Consumer search and double marginalization,” American Economic Review, 105(6), 1683–1710.

[66] Lee, J., G. Gereffi, and J. Beauvais (2012): “Global value chains and agrifood standards: challenges and possibilities for smallholders in developing countries,” Proceedings of the National Academy of Sciences, 109(31), 12326–12331.

[67] Lerner, A. P. (1934): “The Concept of Monopoly and the Measurement of Monopoly Power,” The Review of Economic Studies, 1(3), 157–175.

[68] Lizzeri, A. (1999): “Information revelation and certification intermediaries,” The RAND Journal of Economics, pp. 214–231.

[69] Luco, F., and G. Marshall (2018): “Vertical Integration with Multiproduct Firms: When Eliminating Double Marginalization May Hurt Consumers,” Working Paper.

[70] McFadden, D. (1978): “Modeling the choice of residential location,” Transportation Research Record, (673).

[71] McManus, B. (2007): “Nonlinear pricing in an oligopoly market: the case of specialty coffee,” RAND Journal of Economics, 38(2), 512–532.

[72] Mehta, N., S. Rajiv, and K. Srinivasan (2003): “Price uncertainty and consumer search: A structural model of consideration set formation,” Marketing science, 22(1), 58–84.

[73] Miller, N. H., and M. C. Weinberg (2017): “Understanding the Price Effects of the MillerCoors Joint Venture,” Econometrica, forthcoming.

[74] Miravete, E. J. (2002): “Estimating demand for local telephone service with asymmetric information and optional calling plans,” The Review of Economic Studies, 69(4), 943–971.

[75] Miravete, E. J., and L.-H. Röller (2004a): “Competitive Nonlinear Pricing in Duopoly Equilibrium: The Early U.S. Cellular Telephone Industry,” Working Paper.

[76] Miravete, E. J., and L.-H. Röller (2004b): “Estimating Markups under Nonlinear Pricing Competition,” Journal of the European Economic Association, 2, 526–535.

[77] Moraga-González, J. L., Z. Sándor, and M. R. Wildenbeest (2015): “Consumer search and prices in the automobile market,” Working Paper.

[78] Morgan, P., and R. Manning (1985): “Optimal search,” Econometrica, pp. 923–944.

[79] Mortimer, J. H. (2008): “Vertical contracts in the video rental industry,” The Review of Economic Studies, 75(1), 165–199.

[80] Morton, F. S., F. Zettelmeyer, and J. Silva-Risso (2001): “Internet car retailing,” The Journal of Industrial Economics, 49(4), 501–519.

[81] Nevo, A. (2001): “Measuring market power in the ready-to-eat cereal industry,” Econometrica, 69(2), 307–342.

[82] Nevo, A., J. L. Turner, and J. W. Williams (2016): “Usage-Based Pricing and Demand for Residential Broadband,” Econometrica, 84(2), 411–443.

[83] Newey, W. K., and D. McFadden (1994): “Large sample estimation and hypothesis testing,” Handbook of econometrics, 4, 2111–2245.

[84] Noton, C., and A. Elberg (2018): “Are supermarkets squeezing small suppliers? Evidence from negotiated wholesale prices,” The Economic Journal, 128(610), 1304–1330.

[85] O’Hara, M. (1995): Market microstructure theory, vol. 108. Blackwell Cambridge, MA.

[86] Ohio Supercomputer Center (1987): “Ohio Supercomputer Center,” http://osc.edu/ark:/19495/f5s1ph73.

[87] Pereira, P., and T. Ribeiro (2018): “Evaluating Partial Divestitures When Vertical Relations are Important,” Review of Industrial Organization.

[88] Pires, T. (2016): “Costly search and consideration sets in storable goods markets,” Quantitative Marketing and Economics, 14(3), 157–193.

[89] Quan, T. W., and K. R. Williams (2016): “Product Variety, Across Market Demand Heterogeneity, and the Value of Online Retail,” Working Paper. Cowles Foundation Discussion Paper No. 2054.

[90] Roberts, J. H., and J. M. Lattin (1991): “Development and testing of a model of consideration set composition,” Journal of Marketing Research, pp. 429–440.

[91] Rochet, J.-C., and J. Tirole (2003): “Platform competition in two-sided markets,” Journal of the european economic association, 1(4), 990–1029.

[92] Rubinstein, A., and A. Wolinsky (1987): “Middlemen,” The Quarterly Journal of Economics, 102(3), 581–593.

[93] Rust, J., and G. Hall (2003): “Middlemen versus market makers: A theory of competitive exchange,” Journal of Political Economy, 111(2), 353–403.

[94] Salinger, M. A. (1988): “Vertical mergers and market foreclosure,” The Quarterly Journal of Economics, 103(2), 345–356.

[95] Salz, T. (2017): “Intermediation and Competition in Search Markets: An Empirical Case Study,” Working Paper.

[96] Sibilla, N. (2017): “Connecticut Should Be Tesla Country,” The New York Times, Jul. 7, 2017.

[97] Spengler, J. J. (1950): “Vertical integration and antitrust policy,” Journal of political economy, 58(4), 347–352.

[98] Spulber, D. F. (1995): “Market Making by Price Setting Firms,” Working paper, Northwestern University Discussion Papers.

[99] Spulber, D. F. (1996): “Market microstructure and intermediation,” The Journal of Economic Perspectives, 10(3), 135–152.

[100] Spulber, D. F. (1999): Market microstructure: intermediaries and the theory of the firm. Cambridge University Press.

[101] Stanton, C. T., and C. Thomas (2016): “Landing the first job: The value of intermediaries in online hiring,” The Review of Economic Studies, 83(2), 810–854.

[102] Tirole, J. (1988): The theory of industrial organization. MIT press.

[103] U.K. Office of Fair Trading (2011): “Outdoor Advertising: An OFT market study (OFT 1304, Feb. 2011),” https: //www.lgcplus.com/Journals/3/Files/2011/2/3/oft1304.pdf

[104] U.S. Bureau of Economic Analysis (2017): “Value Added by Industry as a Percentage of Gross Domestic Product,” https://www.bea.gov/iTable/iTableHtml.cfm?reqid=51&step=51&isuri=1&5114=a&5102=5 (accessed on June 14, 2017).

[105] Villas-Boas, S. B. (2007): “Vertical relationships between manufacturers and retailers: Inference with limited data,” The Review of Economic Studies, 74(2), 625–652.

[106] Wolinsky, A. (1986): “True monopolistic competition as a result of imperfect information,” The Quarterly Journal of Economics, 101(3), 493–511.

[107] Wright, R., and Y.-Y. Wong (2014): “Buyers, Sellers, And Middlemen: Variations On Search-Theoretic Themes,” International Economic Review, 55(2), 375–397.

[108] Yanelle, M.-O. (1989): “The strategic analysis of intermediation,” European Economic Review, 33(2-3), 294–301.

[109] Zilibotti, F. (1994): “Endogenous Growth and Intermediation in anArchipelago’Economy,” The Economic Journal, pp. 462– 473.