DP8004 Empirical Evidence on the Role of Non Linear Wholesale Pricing and Vertical Restraints on Cost Pass-Through

Author(s): CĂ©line Bonnet, Pierre Dubois, Sofia Berto Villas-Boas
Publication Date: September 2010
Keyword(s): Non Linear Pricing, Pass-Through, Resale Price Maintenance, Wholesale Price Discrimination.
JEL(s): C13, L13, L41
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=8004

How a cost shock is passed through into final consumer prices may relate to nominal price stickiness and rigidities, the existence of non adjustable cost components, strategic mark-up adjustments, or other contract terms along the supply distribution chain. This paper presents a simple framework to assess the potential role of non linear pricing contracts and vertical restraints such as resale price maintenance or wholesale price discrimination in the supply chain in explaining the degree of pass-through from upstream cost shocks in the ground coffee category to downstream retail prices. We do so in the German coffee market where both upstream and downstream firms make pricing decisions allowing for non linear pricing and vertical restraints. Using counterfactual simulations of an upstream coffee cost shock, we find that the existence of resale price maintenance between manufacturers and retailers increases pass through rate by more than 10 points relative to the case when this assumption is not allowed with non linear pricing or when double marginalization along the distribution chain is present. The intuition for our findings is that resale price maintenance restrictions make it less possible for retailers to perform strategic mark-up adjustments when faced with a cost shock. We also find that the less concentrated upstream sector, and also when faced with less elastic demands, the larger the role of vertical restraints in preventing retailers to perform strategic mark-up adjustments, and thus the higher the pass-through increases.