Modeling the Effects of Mergers in the Retail Sector: A Parsimonious Multilateral Approach

According to EU competition law, mergers that significantly impedes effective competition, particularly by creating or strengthening a dominant position are prohibited. To identify these cases, authorities need a quantifiable model of the relationship between the variables that are affected by the merger and some measure of competition. Furthermore, the authorities must make their decision quickly, rendering deliberate data collection and econometric analyses infeasible in practice. The decision must be based on easily accessible data. In this paper, a simple model of the interaction between the retail and wholesale markets is constructed, calibrated and simulated based on a concrete case (the acquisition and merger of 250 shops previously organized in a voluntary chain of shops comprising roughly half of the market for high-end cosmetics in Denmark). Model simulations predicts that the merger would most likely significantly affect retail prices. The harmful effects are markedly intensified through the possible abuse of buyer power to raise barriers to the market and curb the competitiveness of minor rivals. However, the dominant position is vulnerable if increased profits induce the entrance to the sector of more independent competitors. The competition authorities were justified in conditioning its approval on the removal of contract-based barriers to entry. Analytically, the main results of this work are the following: (1) In a linear model characterized by heterogeneous products and constant marginal costs, the optimal (Nash equilibrium) wholesale price is unaffected by the structure in the retail sector. (2) The effect of buyer power- induced quantity discounts depends crucially on the specific design of the rebate scheme: A relative discount on the list price that the independent shops are charged increases the average retail price, whereas a fixed reduction relative to the pre-merger price reduces the average retail price. (3) Buyer power-induced retail price maintenance (RPM) increases the average retail price. RPM increases the competitiveness and profits of the merged shops only if the producers keep the wholesale prices unchanged. If the producers adjust their wholesale prices, then RPM hurts both the merged and the independent shops and benefits only the producers. The harmful effects on consumer welfare and efficiency are intensified.