Abstract
Pricing schemes in business-to-business (B2B) relationships reflect price discrimination and bargaining over rents. Bargaining outcomes are determined by upstream market power and countervailing buyer power downstream. This paper uses a panel of B2B transactions in the UK brick market to study B2B transaction prices. The empirical analysis identifies three effects on prices: nonlinear volume and freight absorption effects; countervailing power effects that arise from buyers’ local commercial significance; and competition effects that are due to the buyers’ local potential suppliers. And it shows that small buyers benefit more from competition than do large buyers because they are not constrained by the suppliers’ capacity.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
Snyder (1996) provides an explanation for discounts that are granted to large buyers, in the context of an infinitely repeated game with upstream competition vis-à-vis a single downstream buyer; there, buyer size makes a seller’s deviation—in the form of discounts—from upstream collusion profitable relative to possible punishment. Smith and Thanassoulis (2008) demonstrate how upstream competition can endow large buyers with market power by inducing supplier-level volume uncertainty. See also Inderst and Mazzarotto (2006) for a survey of theoretical buyer power results and policy implications.
Chipty and Snyder (1999) show that the effect of size on the buyer’s bargaining position depends on the curvature of the supplier’s gross surplus function. Increases in firm size—e.g. as a consequence of a merger—enhance (worsen) the buyer’s bargaining position if the gross surplus function is concave (convex).
Ellison and Snyder (2010), in a study of US wholesale prices in pharmaceutical markets, distinguish between different buyer types—health maintenance organisations and chain and independent drug stores—controlling for institutional differences in drug administration. Using cross-section data, as opposed to the transaction panel data that are used in this study, they cannot account for buyer heterogeneity within type.
The Competition and Markets Authority (CMA)—established as the successor of the first-stage authority, the Office of Fair Trading (OFT), and the second-stage authority, the Competition Commission (CC), in 2014—has adopted the merger guidance that was originally published by the OFT and the CC.
Competition Commission Guidleines (2003) for market investigation references, paragraph 3.37. Additions in square brackets by the author.
Competition Commission (2007, Appendix C, Table 1).
Competition Commission (2007, Figure 4) shows plant locations. Bricks have a high weight-to-value ratio, while the main fuel to operate kilns, natural gas, has a low weight-to-value ratio. So it is economical to transport the fuel to brick plants at the clay deposits, not to transport clay to delivery points of the natural gas pipeline network. Furthermore, the extracted clay needs to be pre-processed before it can be used to form and fire bricks. Pre-processing involves crushing, filtering, and drying. This requires a processing plant to be close to the clay deposit, even before the brick-forming and firing processes.
The manufacturers in the data also produce a small number of concrete or cinder blocks whose characteristics—notably in terms of load-bearing capacity—are similar to engineering bricks. The CC in its investigation concluded that “the relevant product market affected by the merger [of two brick manufacturers in the sample] included all clay facing and engineering bricks. [...] the relevant product market does not include [...] (b) concrete bricks [i.e. blocks].” (CC Report, paragraph 6) Additions in square brackets are by the author. As concrete blocks do not belong to the same product market as facing and engineering bricks, they are not considered in this analysis.
Competition Commission (2007, paragraphs 8 and 5.20).
They can also be sold to factors, that also buy for resale and that are specialist distributors—acting on behalf of architects or builders—and distinct from merchants in that they do not have physical storage facilities. The accounting data do not distinguish factors from merchants, so the analysis treats them as merchants.
This is confirmed by industry associations that represent brick manufacturers, builders, and merchants. One of the four manufacturers in the data, for example, in 2008 had five regional sales offices in England, one in Scotland, and one in Northern Ireland.
Competition Commission (2007, paragraph 4.54).
I have access only to manufacturer data, not merchant data. Not all manufacturer data provide consistent information on haulage. Therefore, the data do not permit a comprehensive investigation of haulage in the UK brick industry.
Framework agreements set out annual matrices of ex-works and/or delivered prices vis-à-vis brick specifications and target volumes. These are not formal contracts, but are merely indicative commercial conditions subject to which transactions can, but need not, be called off.
According to the UK National Association of Estate Agents, the average detached house in 2006 required 5400 bricks. The CC report, paragraph 4.30, states 7000–10,000 bricks per dwelling.
The restoration and modernisation of the station about a decade ago required 60 million bricks; http://www.bifm.org.uk/bifm/filegrab/StPancrasFactSheet.pdf?type=documents&ref=2965.
Flues are outlets of waste gases, from boilers, heating, and ventilation systems.
Competition Commission (2007, paragraph 4.45).
Prices of more than £4.50 per hand-made brick are not uncommon, according to manufacturers’ online product price lists.
This appears to be the case of a brick delivery in Cornwall that originated at a plant in the Newcastle area.
Competition Commission (2007, paragraph 5.44).
Competition Commission (2007, Figure 4) shows the locations of manufacturing plants.
See Competition Commission (2007, Appendix C, paragraph 23) for the non-binding nature of framework agreements.
See Competition Commission (2007, paragraph 5).
According to CEBR (2016), in 2006 the cost of housing per brick was £64.59 in London and £52.37 in Cambridge, for example. This compares to an average price of a facing bricks of £0.75 in the contract data.
See Competition Commission (2007, paragraph 4.32 and Appendix C, paragraphs 15 and 18).
The specification of the pricing equation that is linear in the levels of this variable produced a better fit than a specification that is linear in the log of this variable. There are no a priori theoretic reasons for either specification. This is an empirical matter. The semi-log specification in this application means that the elasticity of price with respect to the buyer’s local commercial significance is not constant, but varies with the level of that variable.
An urban versus rural split is motivated by construction restrictions that are due to rigid nature conservation regulations in the UK.
To economise on space, the first-stage coefficient estimates of the remaining coefficients are omitted, but are available on request.
For both builders and merchants, F-tests failed to reject the hypothesis that interactions with a dummy variable for “small” are jointly zero at the 5% level. The result is stronger for merchants due to the larger sample size: 1161 merchants account for 90.8 % of contracts in the data.
Large buyers cannot pretend to be small by spreading the required volume across several manufacturers, however. Bricks are differentiated products, notably with regard to their aesthetic appearance. This is a consequence of the particular clay that is used. This means, in particular, that products by different manufacturers do not look the same. Therefore, for a given project, only bricks from a single manufacturer can be used, and order division is not an option.
Builders have little, if any, incentive to merge. Delivery by the manufacturer is to a location—a construction site—and the number of bricks that are required at that location is determined by the nature of the building. With bricks being a small part of the overall construction cost, one would not redesign to change the number of bricks required. A merged firm or cooperative would have to arrange transport from the location to which the manufacturer delivers to any other location. To the extent that there is a cost advantage in this, merchants do it already.
The econometric evidence on nonlinear volume effects is presented below.
Since the network of large merchant store locations (large merchants have several hundred stores in the UK) is much denser than the network of manufacturing plants (54), virtually all transactions in the data bypass a large merchant—in the sense that the distance between delivery site and the chosen manufacturing plant exceeds the distance to the closest store of one of the five largest merchants. 99.8% (99.7%) of small builder (merchant) contracts (with manufacturers) bypass the closest of the five largest merchants. And 95.2% (95.1%) of small builders (merchants) have contracts only with manufacturers that bypass these merchants. The median bypass distance is 106 km (93.6 km) for builders (merchants). This suggests that the small buyers in the data reveal themselves as being selective with whom they deal. They could have bought from at least one of the five large merchants, but chose to bypass that merchant and to buy from a manufacturer instead.
Merchants carry a wide variety of construction materials other than bricks, including timber, plumbing, electric equipment, paints, etc.
As the estimated model is log-linear, these estimates are calculated as \(\exp (\hat{\alpha })-1\).
Competition Commission (2007, paragraphs 5 and 9, and paragraphs 4.33–4.37).
e.g. Paragraphs 4.61–4.64.
Separate data contain some coarse information on cost at the manufacturing plant level, but even this information does not appear to be consistent across all pants. Therefore, it is not utilised in this study.
Examples of other inquiries into bulk industries where buyer power was considered are Office Of Fair Trading OFT (2011a, b); Competition Commission (2012a, b). An example of a business-to-business relationship that involves bilateral bargaining for services is statutory company audits. The OFT refers to countervailing power of some auditees in its referral document to the CC; see OFT (2011c, paragraph 5.25).
References
Adelman, M. (1959). A & P: A study in price-cost behavior and public policy. Cambridge: Harvard University Press.
Beckert, W., Smith, H., & Takahashi, Y. (2016). Competitive price discrimination in a spatially differentiated intermediate goods market. Unpublished manuscript.
Bonnet, C., & Dubois, P. (2010). Non-linear contracting and endogenous buyer power between manufacturers and retailers: Empirical evidence on food retailing in France. TSE working paper, no. 10-190.
Boulding, W., & Staelin, R. (1990). Environment, market share and market power. Management Science, 36, 1160–1177.
Bower, R. (1964). Decreasing marginal costs in brick production. The Journal of Industrial Economics, 13(1), 1–10.
Boyer, K. (1996). Can market power really be estimated? Review of Industrial Organization, 11(1), 115–124.
Brooks, D. (1973). Buyer concentration: A forgotten element in market structure model. Industrial Organization Review, 1(3), 151–163.
Buzzell, R., Gale, B., & Sultan, R. (1975). Market share—A key to profitability. Harvard Business Review, 53, 97–106.
CEBR. (2016). Not just another brick in the wall. https://www.cebr.com/reports/not-just-another-brick-in-the-wall.
Chipty, T., & Snyder, C. (1999). The role of firm size in bilateral bargaining: A study of the cable television industry. The Review of Economics and Statistics, 81(2), 326–340.
Clevenger, T., & Campbell, G. (1977). Vertical organization: A neglected element in market structure–performance models. Industrial Organization Review, 5(1), 60–66.
Competition Commission. (2003). Market investigation references: Competition commission guidelines. http://webarchive.nationalarchives.gov.uk/20111202165157.. http://www.competition-commission.org.uk/rep_pub/rules_and_guide/pdf/cc3.pdf.
Competition Commission. (2007). Wienerberger finance service BV and Baggeridge Plc. https://www.gov.uk/cma-cases/wienerberger-finance-service-bv-baggeridge-brick-plc-merger-inquiry-cc.
Competition Commission. (2008). Groceries market investigation. http://webarchive.nationalarchives.gov.uk/20120120004636. http://www.competition-commission.org.uk//rep_pub/reports/2008/538grocery.htm.
Competition Commission. (2012a). Aggregates, cement, and ready-mix concrete market investigation. https://www.gov.uk/cma-cases/aggregates-cement-and-ready-mix-concrete-market-investigation.
Competition Commission. (2012b). Anglo American PLC and Lafarge SA. https://www.gov.uk/cma-cases/anglo-american-plc-lafarge-s-a-merger-inquiry.
Crawford, G., & Yurukoglu, A. (2012). The welfare effects of bundling in multichannel television markets. The American Economic Review, 102(2), 643–685.
Directorate General Competition DGComp. (1998). Case no IV/M.1245 -Valeo / ITT industries. http://ec.europa.eu/competition/mergers/cases/decisions/m1245_en.pdf.
Directorate General Competition DGComp. (2010). Best practices for the submission of economic evidence and data collection in cases concerning the application of articles 101 and 102 treaty on the functioning of the European Union and in merger cases. http://ec.europa.eu/competition/consultations/2010_best_practices/best_practice_submissions.pdf.
Dobson, P., & Waterson, M. (1997). Countervailing power and consumer prices. The Economic Journal, 107(441), 418–430.
Draganska, M., Klapper, D., & Villas-Boas, S. (2010). A larger slice or a larger pie? An empirical investigation of bargaining power in the distribution channel. Marketing Science, 29(1), 57–74.
Ellison, S., & Snyder, C. (2010). Countervailing buyer power in wholesale pharmaceuticals. The Journal of Industrial Economics, 58(1), 32–53.
Galbraith, J. (1952). American capitalism. The concept of countervailing power. Boston: Houghton Mifflin.
Galbraith, J. (1954). Countervailing power. Papers and proceedings of the sixth annual meeting of the American Economic Association (pp. 1–6).
Giulietti, M. (2007). Buyer and seller power in grocery retailing: Evidence from Italy. Revista de Economia del Rosario, 10(2), 109–125.
Gowrisankaran, G., Nevo, A., & Town, R. (2014). Mergers when prices are negotiated: Evidence from the hospital industry. The American Economic Review, 105(1), 172–203.
Grennan, M. (2013). Price discrimination and bargaining: Empirical evidence from medical devices. The American Economic Review, 103(1), 145–177.
Horn, H., & Wolinsky, A. (1988). Bilateral monopolies and incentives for merger. The RAND Journal of Economics, 19(3), 408–419.
Hortaçsu, A., & Syverson, C. (2007). Cementing relationships: Vertical integration, foreclosure, productivity, and prices. Journal of Political Economy, 115(2), 250–301.
Hyde, C., & Perloff, J. (1995). Can market power be estimated? Review of Industrial Organization, 10(4), 465–485.
Inderst, R., & Mazzarotto, N. (2006). Buyer power: Sources, consequences, and policy responses. Unpublished manuscript.
Inderst, R., & Valletti, T. (2009). Price discrimination in input markets. The RAND Journal of Economics, 40(1), 1–19.
Inderst, R., & Wey, C. (2003). Bargaining, mergers, and the technology choice in bilaterally oligopolistic industries. The RAND Journal of Economics, 34(1), 1–19.
Katz, M. (1987). The welfare effects of third-degree price discrimination in intermediate good markets. The American Economic Review, 77(1), 154–167.
Lustgarten, S. (1975). The impact of buyer concentration in manufacturing industries. The Review of Economics and Statistics, 57(1), 125–132.
McAfee, P., & Schwartz, M. (1994). Opportunism in multilateral vertical contracting: Nondiscrimination, exclusivity, and uniformity. The American Economic Review, 84(1), 201–230.
McGukin, R., & Chen, H. (1976). Interactions between buyer and seller concentration: Nondiscrimination, exclusivity, and uniformity. Industrial Organization Review, 4, 123–132.
McKie, J. (1959). Tin cans and tin plate. Cambridge, MA: Harvard University Press.
Miller, N., & Osborne, M. (2014). Spatial differentiation and price discrimination in the cement industry: Evidence from a structural model. The RAND Journal of Economics, 45(2), 221–247.
Office of Fair Trading OFT. (2011a). Aggregates, cement and ready-mix concrete market investigation. https://www.gov.uk/cma-cases/aggregates-cement-and-ready-mix-concrete-market-investigation.
Office of Fair Trading OFT. (2011b). Proposed Joint Venture between Anglo American PLC and Lafarge SA. https://www.gov.uk/cma-cases/anglo-american-plc-lafarge-s-a-merger-inquiry.
Office of Fair Trading OFT. (2011c). Statutory audit services market investigation. https://www.gov.uk/cma-cases/statutory-audit-services-market-investigation.
Smith, H., & Thanassoulis, J. (2008). Upstream competition and downstream buyer power. Unpublished manuscript.
Snyder, C. (1996). A dynamic theory of countervailing power. The RAND Journal of Economics, 27(4), 747–769.
Stigler, G. (1949). A theory of delivered price systems. The American Economic Review, 39(6), 1144–1159.
Stole, L., & Zwiebel, J. (1996). Intra-firm bargaining under non-binding contracts. The Review of Economic Studies, 63(3), 375–410.
Syverson, C. (2007). Prices, spatial competition and heterogeneous producers: An empirical test. The Journal of Industrial Economics, 55(2), 197–222.
Syverson, C. (2008). Ready-mixed concrete. Journal of Economic Perspectives, 22(1), 217–233.
Thisse, J., & Vives, X. (1988). On the strategic choice of spatial price policy. The American Economic Review, 78(1), 122–137.
Villas-Boas, S. (2007). Vertical relationships between manufacturers and retailers: Inference with limited data. The Review of Economic Studies, 74(2), 626–652.
Acknowledgements
This paper is a non-structural companion paper to my structural work with Howard Smith and Yuya Takahashi. I am grateful for valuable comments and suggestions by Lawrence J. White and two anonymous referees, and for helpful discussions with Howard Smith and Yuya Takahashi, as well as with Richard Blundell, Kate Collyer, Yongmin Chen, Rachel Griffith, Dave Jevons, Sandeep Kapur, Nicola Mazzarotto, Arina Nikandrova, Hiroshi Ohashi, David Sappington, Philipp Schmidt-Dengler, Ron Smith, John Thanassoulis, Mike Whinston, and seminar audiences at Cambridge, the IFS, ESMT, HKUST, and UEA. I am indebted to executives of the UK brick industry for letting me use their data. I also thank the Economic and Social Research Council for financial support under Grant ES/M007421/1. The views expressed in this paper are the sole responsibility of the author.
Author information
Authors and Affiliations
Corresponding author
Appendix: Supplementary Results
Rights and permissions
About this article
Cite this article
Beckert, W. An Empirical Analysis of Countervailing Power in Business-to-Business Bargaining. Rev Ind Organ 52, 369–402 (2018). https://doi.org/10.1007/s11151-017-9607-7
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11151-017-9607-7