A Study of Vertical Integration and Vertical Divestiture: The Case of Store Brand Milk Sourcing in Boston

Authors


  • I thank Alessandro Bonanno, Ron Cotterill, Jean-Pierre Dubé, Paul Ellickson, Avi Goldfarb, Renna Jiang, Adam Rabinowitz, Peter Rossi, Sylvie Tchumtchoua, and Gautam Tripathi for valuable discussions and comments leading to improvements in this article. This article also benefited from comments by seminar participants at the 2010 International Industrial Organization Conference in Vancouver, Canada. I also thank Christopher Jeffords for research assistance. Any errors are my own.

Abstract

This article investigates whether a retailer’s store brand supply source impacts vertical pricing and supply channel profitability. Using chain-level retail scanner data, a random coefficients logit demand model is estimated employing a Bayesian estimation approach. Supply models are specified conditional on demand parameter estimates. Bayesian decision theory is applied to select the best fitting pricing model. Results indicate that a vertically integrated retailer engages in linear pricing for brand manufacturers’ products while competing retailers make nonlinear pricing contracts with brand manufacturers for branded products and store brands. A simulated vertical divestiture based on real world events provides evidence for improved channel efficiency.

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