Elberg, Andrés

Noton, Carlos

LSE Research Online

Big	box	retailers	aren’t	always	able	to	squeeze	smallsuppliersHas	the	rise	and	consolidation	of	‘big	box’	retailers,	such	as	Walmart,	Tesco	and	Carrefour,	undermined	the	ability	ofsuppliers,	especially	small	ones,	to	earn	sizeable	profits?	Are	small	suppliers	that	bargain	with	these	giants	doomedto	earn	a	meagre	share	of	the	‘channel	surplus’	–	the	difference	between	retail	revenues	and	variable	productioncosts?While	the	answer	to	these	questions	has	been	hotly	debated	among	both	commentators	and	academics,	a	clearanswer	based	on	hard	evidence	has	been	elusive.	The	paucity	of	research	examining	this	question	can	beexplained,	primarily,	by	the	lack	of	appropriate	data.Measuring	the	channel	surplus	requires	a	good	estimate	of	production	costs,	which	is	usually	unavailable	toresearchers	since	it	is	seen	as	sensitive	information	by	manufacturers.	Similarly,	being	able	to	determine	the	share	ofthe	pie	obtained	by	retailers	and	suppliers	requires	observing	the	negotiated	wholesale	prices	(those	paid	by	retailersto	suppliers),	which	are	not	publicly	observed	due	to	confidentiality.Our	study	tackles	this	challenge	by	using	a	novel	dataset	that	includes	wholesale	prices	paid	by	major	supermarketchains	in	Chile	to	packaged	coffee	suppliers	over	the	period	from	2005	to	2007.	We	focus	on	the	Chilean	packagedcoffee	industry	for	two	main	reasons:First,	the	industry	is	characterised	by	the	interaction	of	two	large	retailers	that	bargain	for	their	share	of	thechannel	surplus	with	suppliers	of	varying	size,	the	dominant	one	being	the	large	multinational	Nestlé.Second,	coffee	production	costs	are	easy	to	estimate,	as	the	production	technology	is	relatively	simple	and	thelargest	share	(at	least	50	per	cent)	of	costs	is	accounted	for	by	green	coffee	beans,	for	which	prices	are	publiclyobservable.Combining	data	on	prices	at	the	retail	and	wholesale	levels,	quantities	and	estimated	coffee	production	costs,	we	findthat	while	the	largest	supplier,	Nestlé,	is	able	to	secure	a	large	fraction	of	the	pie	(around	65	per	cent)	the	medianfraction	of	the	surplus	obtained	by	other	smaller	suppliers	is	a	sizeable	41	per	cent.	This	indicates	that	it	is	notnecessarily	the	case	that	small	suppliers	bargaining	with	large	supermarket	chains	are	doomed	to	earn	negligibleprofits.	Some	are	able	to	secure	relatively	large	fractions	of	the	surplus	at	stake	in	negotiations	with	retailers	in	spiteof	their	small	market	sizes.LSE Business Review: Big box retailers aren’t always able to squeeze small suppliers Page 1 of 2		Date originally posted: 2018-05-24Permalink: http://blogs.lse.ac.uk/businessreview/2018/05/24/big-box-retailers-arent-always-able-to-squeeze-small-suppliers/Blog homepage: http://blogs.lse.ac.uk/businessreview/What	explains	the	ability	of	small	suppliers	to	earn	such	a	large	share	of	the	channel	surplus?	To	answer	thisquestion,	we	decompose	the	fraction	of	the	channel	surplus	earned	by	the	two	‘players’	in	the	negotiation	into	twocomponents.One	component	is	what	is	known	as	bargaining	position	and	is	the	difference	between	agreement	and	disagreementpayoffs.	Disagreement	payoffs	are	the	payments	for	both	players	in	a	hypothetical	scenario	where	the	retailer	doesnot	carry	any	of	the	manufacturer’s	products.	Since	disagreements	are	not	observed	in	the	data,	the	researchersestimate	a	demand	system	and	use	these	demand	estimates	to	compute	a	measure	of	the	profits	that	thesupermarket	would	obtain	if	a	given	supplier’s	products	were	taken	off	its	shelves.	The	less	substitutable	(moredifferentiated)	the	product	is,	the	lower	the	profits	a	supermarket	would	obtain	in	the	event	of	a	disagreement	in	theirnegotiations	with	the	supplier.	In	this	case,	the	supplier	is	in	a	better	bargaining	position.The	second	component	of	the	fraction	of	the	channel	surplus	earned	by	a	player	is	what	we	call	bargaining	power	orbargaining	weight	–	a	broad	component	encompassing	deep	factors	such	as	relative	bargaining	skills,	patience	andrisk	aversion.The	study	finds	that	the	relatively	large	share	of	the	surplus	earned	by	small	coffee	manufacturers	can	berationalised	by	retailers’	low	‘outside	options’	(disagreement	profits	are	about	27	per	cent	of	agreement	profits).	Theresults	suggest	that	the	most	likely	explanation	for	small	manufacturers’	ability	to	capture	value	is	that	they	providedifferentiated	products	to	a	small	but	highly	loyal	group	of	customers.♣♣♣Notes:This	blog	post	is	based	on	the	authors’	paper	Are	Supermarkets	Squeezing	Small	Suppliers?	Evidence	fromNegotiated	Wholesale	Prices,	The	Economic	Journal,	May	2018.The	post	gives	the	views	of	its	authors,	not	the	position	of	LSE	Business	Review	or	the	London	School	ofEconomics.Featured	image	credit:	Photo	by	ElasticComputeFarm,	under	a	CC0	licenceWhen	you	leave	a	comment,	you’re	agreeing	to	our	Comment	Policy.Carlos	Noton	is	an	assistant	professor	at	the	Centre	for	Applied	Economics	in	the	department	ofindustrial	engineering	of	the	University	of	Chile,	and	adjunct	researcher	of	the	Millennium	Institute	forResearch	in	Market	Imperfections	and	Public	Policy.	His	research	interests	are	in	the	field	of	industrialorganisation,	applied	econometrics	and	consumer	behaviour,	and	his	work	has	been	published	in	TheEconomic	Journal	and	The	International	Journal	of	Industrial	Organization.	Professor	Noton	holds	aPh.D.	in	economics	from	the	University	of	California,	Berkeley,	and	a	M.A.	in	economics	from	theUniversity	of	Chile.	Previously,	he	was	an	assistant	professor	at	the	economics	department	of	theUniversity	of	Warwick,	UK.	Andrés	Elberg	is	an	assistant	professor	at	Pontificia	Universidad	Católica	de	Chile’s	School	ofManagement.	His	research	interests	include	empirical	quantitative	marketing	and	empirical	industrialorganisation,	with	specific	interests	in	pricing,	promotions	and	retailing.	His	work	has	been	published	inThe	Economic	Journal,	The	Journal	of	International	Economics,	Emerging	Markets	Finance	andTrade,	and	the	Latin	American	Journal	of	Economics.	Professor	Elberg	earned	a	Ph.D.	in	economicsfrom	the	University	of	California,	Berkeley,	an	MPA/ID	from	Harvard	University,	an	M.A.	in	economicsfrom	Pontificia	Universidad	Católica	de	Chile	and	a	B.Sc.	in	business	and	economics	from	UniversidadAdolfo	Ibáñez.	LSE Business Review: Big box retailers aren’t always able to squeeze small suppliers Page 2 of 2		Date originally posted: 2018-05-24Permalink: http://blogs.lse.ac.uk/businessreview/2018/05/24/big-box-retailers-arent-always-able-to-squeeze-small-suppliers/Blog homepage: http://blogs.lse.ac.uk/businessreview/

Big box retailers aren't always able to squeeze small suppliers

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Big box retailers aren't always able to squeeze small suppliers

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