Vertical Integration with Multiproduct Firms: When Eliminating Double Marginalization May Hurt Consumers Fernando Luco Texas A&M

Guillermo Marshall University of Illinois

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Many Industries Look Like This U1

U2

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Consumers

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Many Industries Look Like This U1

U2

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How do we think about vertical relationships?

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Many Industries Look Like This U1

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Vertical mergers are often evaluated based on the trade-off between • Efficiencies • Market foreclosure

A third effect comes into play in multiproduct industries • Partial elimination of double margins changes pricing incentives • May cause price increases even in absence of market foreclosure 2 30

Example

U1

U2

ω1

ω2

Retailer Product 1 p1

Product 2 p2

Consumers

3 30

Example Suppose the Retailer integrates with U1 , partially eliminating double margins. U1

U2

0

ω1 < ω1

ω1 decreases, causing

ω2

Retailer Product 1 p1

Product 2 p2

Consumers

3 30

Example Suppose the Retailer integrates with U1 , partially eliminating double margins. U1

U2

ω1 decreases, causing • a downward pressure on p1

0

ω1 < ω1

ω2

• Efficiency effect

• an upward pressure on p2 to divert Retailer Product 1 0 p1 < p1

Product 2 0 p2 > p2

demand to product 1, if products are substitutes

Consumers

3 30

Example Suppose the Retailer integrates with U1 , partially eliminating double margins. U1

U2

ω1 decreases, causing • a downward pressure on p1

0

ω1 < ω1

ω2

• Efficiency effect

• an upward pressure on p2 to divert Retailer Product 1 0 p1 < p1

Product 2 0 p2 > p2

Consumers

demand to product 1, if products are substitutes

If products are substitutes, both prices may increase and welfare decrease (Edgeworth 1925, Salinger 1991). 3 30

Example Suppose the Retailer integrates with U1 , partially eliminating double margins. U1

U2

ω1 decreases, causing • a downward pressure on p1

0

ω1 < ω1

ω2

• Efficiency effect

• an upward pressure on p2 to divert Retailer Product 1 0 p1 < p1

Product 2 0 p2 > p2

Consumers

demand to product 1, if products are substitutes • Edgeworth-Salinger effect

If products are substitutes, both prices may increase and welfare decrease (Edgeworth 1925, Salinger 1991). 3 30

This Paper

Is the Edgeworth-Salinger effect relevant for the evaluation of vertical mergers? • Should it be considered when evaluating vertical mergers? • What is its magnitude? • How does it interact with efficiency gains?

4 30

Context: Carbonated Beverage Industry in the U.S. • Upstream firms sell syrup to downstream bottlers • Bottlers can work with more than one upstream firm and have

exclusive territories.

Bottler Agreement

• In 2009 and 2010, PepsiCo and The Coca-Cola Company integrated

with some of their bottlers. • Not all areas of the country were affected by vertical integration • Bottlers bottled Dr Pepper Snapple Group brands in some areas of

the country • Partial elimination of double marginalization

• No evidence of market foreclosure. • Coca Cola and PepsiCo acquired licenses to continue selling Dr

Pepper SG products • The FTC cleared the transactions subject to behavioral remedies 5 30

Preview of Results and Implications Vertical integration caused: 1

a 1–2 percent decrease in prices of Coca-Cola and Pepsi brands bottled by a VI bottler.

2

a 3–4 percent increase in prices of Dr Pepper brands bottled by a VI bottler.

3

most of Dr Pepper brands were affected by the Edgeworth-Salinger effect.

Main takeaways: • The Edgeworth-Salinger effect is relevant and it should be

considered when evaluating vertical mergers. • The impact of efficiency gains on prices is overestimated if the

Edgeworth-Salinger effect is not considered. 6 30

Literature Review The impact of vertical integration on prices and consumer welfare • Theory: Salinger (1988), Perry (1989), Ordover et al (1990), Hart el

al (1990), Bolton and Whinston (1991), Reiffen (1992), Riordan and Salop (1995), Riordan (1998), Choi and Yi (2000), Chen (2001), Lafontaine and Slade (2007), and others • Empirical evidence: Chipty (2001), Hastings and Gilbert (2005),

Hortacsu and Syverson (2007), Crawford et al (2017), and others Edgeworth paradox + vertical integration • Edgeworth (1925), Hotelling (1932), Salinger (1991)

7 30

Outline

1

The transactions

2

Data

3

Research design and identification threats

4

Results and discussion

8 30

The Transactions

• In 2009 and 2010, Coca-Cola and Pepsi acquired some of their

independent bottlers. Why? • Decreasing demand for carbonated sodas • Increasing input costs (e.g., plastic, high-fructose corn syrup).

• Bottlers represented around 70% of sales for Coca-Cola and Pepsi,

and 35% for DPSG.

9 30

The Transactions

• Coca Cola and PepsiCo acquired licenses to continue selling Dr

Pepper SG products • Not all areas of the country were affected by vertical integration • Bottlers bottled Dr Pepper Snapple Group brands in some areas of

the country • Partial elimination of double marginalization

• The FTC claimed the transactions violated Section 5 of the FTC Act

and Section 7 of the Clayton Act • Remedies mostly involved the use of sensitive information.

10 30

Hypothesis: Partial VI Changes Pricing Incentives What do we expect to see? The mergers • eliminated double marginalization for “own brands” bottled by VI

bottlers • did not eliminate double marginalization for Dr Pepper brands

bottled by VI bottlers We would expect VI to cause • a decrease in prices of own brands, • an increase in prices of Dr Pepper brands

Overall price effect is ambiguous.

11 30

Data • IRI Marketing Data Set • Weekly scanner data for the years 2007 to 2012 across 50 MSAs • An observation is a store–week–brand–size combination • We focus on popular products: 105 brand–size combinations • Example: 67oz bottle of Diet Coke

• Beverage Digest territory maps • Territory of each bottler

• FTC documents • Counties that were exposed to Edgeworth-Salinger effect

Show map

12 30

Identification in Practice: The Coca-Cola Company a) North-East

b) Houston

Legend No VI VI, Coke bottler does not bottle Dr Pepper VI, Coke bottler bottles Dr Pepper

13 30

Threats to Identification

1

Changes in advertising, rebate policies, or input costs at the upstream firm level.

2

VI may have happened in markets where PepsiCo and Coca-Cola had greater market power.

3

Preexisting price trends specific to areas eventually impacted by VI

We use the panel structure to tackle (1)–(2); and address (3) both using summary statistics and a dynamic difference-in-difference framework

14 30

Threats to Identification: Data • Coca-Cola products

15 30

Threats to Identification: Data • Pepsi products

15 30

Threats to Identification: Data • Dr Pepper products

15 30

Specification We estimate several versions of

log(pricej,s,w ) =VIbottler(j,s),w · OwnBrandj β Own

+ VIbottler(j,s),w · DrPepperBrandj β DrPepper + λs + γw,county(s) + δj,county(s),season(w) + φfirm(j),w + ε j,s,w

16 30

Specification We estimate several versions of

log(pricej,s,w ) =VIbottler(j,s),w · OwnBrandj β Own

+ VIbottler(j,s),w · DrPepperBrandj β DrPepper + λs + γw,county(s) + δj,county(s),season(w) + φfirm(j),w + ε j,s,w • φfirm(j),w : national changes at the parent-firm level.

16 30

Specification We estimate several versions of

log(pricej,s,w ) =VIbottler(j,s),w · OwnBrandj β Own

+ VIbottler(j,s),w · DrPepperBrandj β DrPepper + λs + γw,county(s) + δj,county(s),season(w) + φfirm(j),w + ε j,s,w • φfirm(j),w : national changes at the parent-firm level. • γw,county(s) : local shocks.

16 30

Specification We estimate several versions of

log(pricej,s,w ) =VIbottler(j,s),w · OwnBrandj β Own

+ VIbottler(j,s),w · DrPepperBrandj β DrPepper + λs + γw,county(s) + δj,county(s),season(w) + φfirm(j),w + ε j,s,w • φfirm(j),w : national changes at the parent-firm level. • γw,county(s) : local shocks. • λs and δj,county(s),season(w) : local conditions and seasonal effects.

16 30

Specification We estimate several versions of

log(pricej,s,w ) =VIbottler(j,s),w · OwnBrandj β Own

+ VIbottler(j,s),w · DrPepperBrandj β DrPepper + λs + γw,county(s) + δj,county(s),season(w) + φfirm(j),w + ε j,s,w • φfirm(j),w : national changes at the parent-firm level. • γw,county(s) : local shocks. • λs and δj,county(s),season(w) : local conditions and seasonal effects. • ε j,s,w : clustered at the county level.

Legend No VI VI, Coke bottler does not bottle Dr Pepper VI, Coke bottler bottles Dr Pepper

16 30

Edgeworth-Salinger Effect is Economically Relevant Average effect on Own Brands (β Own ) Average effect on Dr Pepper Brands (β DrPepper ) Observations R2

log(price) -0.014*** (0.003) 0.039*** (0.002) 37,106,025 0.893

Notes: Standard errors clustered at the county level in parentheses. *** p < 0.01. Specifications include controls for feature and display, store FE, week × parent company FE, week × county FE, and product × county × season-of-year FE.

Back-of-the-Envelope: Weighted effect, by pre-merger market shares, is a 0.9% decrease in paid prices. 17 30

Vertical Integration Increased Prices

Average effect of Vertical Integration (β Own = β DrPepper )

log(price) 0.018*** (0.003)

Observations R2

37,106,025 0.893

Notes: Standard errors clustered at the county level in parentheses. *** p < 0.01. Specifications include controls for feature and display, store FE, week × parent company FE, week × county FE, and product × county × season-of-year FE.

18 30

Edgeworth-Salinger Effect is Economically Relevant Average effect on Own Brands (Coca-Cola) (β Own,CocaCola ) Average effect on Dr Pepper Brands (Coca-Cola) (β DrPepper,CocaCola )

log(price) -0.010*** (0.004) 0.042** (0.004)

Average effect on Own Brands (PepsiCo) (β Own,Pepsi )

-0.021*** (0.006)

Average effect on Dr Pepper Brands (PepsiCo) (β DrPepper,Pepsi )

0.031*** (0.003)

Observations R2

37,106,025 0.893

Notes: Standard errors clustered at the county level in parentheses. *** p < 0.01. Specifications include controls for feature and display, store FE, week × parent company FE, week × county FE, and product × county × season-of-year FE.

19 30

Dynamic Difference-in-Differences

A dynamic difference-in-difference research design allows us to

• Study differences in pre-trends, and • Determine when the effect starts to take place.

20 30

Dynamic Difference-in-Differences .04

• Price differences over time: VI versus no VI

-.01

0

Price coefficients .02 .03 .01

Quarter before first transactions

Q1/08

Q2/09

Q3/11 21 30

Product-level Analysis: Prices We estimate j

log(pricej,s,w ) =VIbottler(j,s),w · β VI + λs + φw + ε j,s,w ∀j

22 30

Product-level Analysis: Prices We estimate j

log(pricej,s,w ) =VIbottler(j,s),w · β VI + λs + φw + ε j,s,w ∀j 1

Cumulative Probability

.8

.6

.4

.2

Own brands Dr Pepper brands

0 −.05

0

.05

.1

Estimated coefficent on Vertical Integration

22 30

Product-level Analysis: Elasticities 1

Cumulative Probability

.8

.6

.4

.2

Own brands Dr Pepper brands

0 −8

−6

−4

−2

0

2

4

Elasticity Vertical lines denote median elasticities

23 30

Efficiency without Edgeworth-Salinger When the Edgeworth-Salinger effect is present, several things happen • VI causes a downward pressure on the price of own brands • VI causes an upward pressure on the price of rival brands • the increase in prices of rival brands leads to relative increases in

prices of own brands because of strategic complementarities To isolate efficiency gains, we need to estimate the impact of VI in areas that are not exposed to the Edgeworth-Salinger effect.

24 30

Efficiency without Edgeworth-Salinger

Average effect on Own Brands (β Own )

log(price) -0.014*** -0.024*** (0.003) (0.004)

Average effect on Dr Pepper Brands (β DrPepper )

0.039*** (0.002)

Observations R2

37,106,025 0.893

2,967,386 0.910

Notes: Standard errors clustered at the county level in parentheses. *** p < 0.01. Specifications include controls for feature and display, store FE, week × parent company FE, week × county FE, and product × county × season-of-year FE. 25 30

Bordering Counties a) North-East

b) Houston

Legend No VI VI, Coke bottler does not bottle Dr Pepper VI, Coke bottler bottles Dr Pepper

26 30

Bordering Counties Average effect on Own Brands (β Own )

log(price) -0.012*** (0.003)

Average effect on Dr Pepper Brands (β DrPepper )

0.037*** (0.003)

Average effect on Own Brands (Coca-Cola) (β Own,CocaCola )

-0.015*** (0.005)

Average effect on Dr Pepper Brands (Coca-Cola) (β DrPepper,CocaCola )

0.031** (0.005)

Average effect on Own Brands (PepsiCo) (β Own,Pepsi )

-0.006 (0.005)

Average effect on Dr Pepper Brands (PepsiCo) (β DrPepper,Pepsi )

0.029*** (0.005)

Observations R2

14,285,223 0.886

14,285,223 0.886

Notes: Standard errors clustered at the county level in parentheses. *** p < 0.01. 27 30

Regular and Sale Price Packaged goods are often sold at reduced prices (sales). Does VI affect both regular and sales prices similarly? (1)

(3)

(4) Sale indicator

VI · Own product bottled by Coca-Cola or PepsiCo bottler

Regular Price Subsample -0.018*** (0.003)

(2) log(price) Sale Price Subsample -0.013*** (0.003)

Full Sample -0.014*** (0.003)

Full Sample -0.006 (0.005)

VI · Rival product bottled by Coca-Cola or PepsiCo bottler

0.052*** (0.003)

0.026*** (0.003)

0.039*** (0.002)

0.009** (0.003)

21,679,165 0.935

15,422,052 0.921

37,106,025 0.893

37,124,313 0.383

Observations R2

Notes: Standard errors clustered at the county level (436 clusters) in parentheses. ** p < 0.05, *** p < 0.01. All specifications include controls for feature and display, store FE, week × parent company FE, week × county FE, and product × county × season-of-year FE.

28 30

Alternative Explanations

1

Market foreclosure: Unlikely.

2

Capacity constraints: Maybe in the short run, unlikely in the long run.

3

Post-merger changes in the frequency of sales of non-VI bottlers: We reject this.

4

Closed vs. Quantity-Weighted Prices: Not driving the results. Results

29 30

Discussion • Vertical mergers often evaluated based on trade-off between

efficiencies and foreclosure • Theory: Partial elimination of double margins may hurt consumers

in multiproduct industries • First paper to provide causal evidence of the relevance of the

Edgeworth-Salinger effect for vertical merger evaluation • The Edgeworth-Salinger effect is of the same magnitude as the

efficiency effect • It counteracts efficiency gains

30 30

Thank you!

Bottler Agreement The Bottler Agreement governs the relationship between the upstream firm and the bottlers. In general, it establishes that 1

Upstream firms have the right to set the price at which they sell to the bottler. BA 1

2

Bottlers have the right to choose the price at which they sell to their customers, subject to a maximum price. BA 2

3

Local advertising and marketing campaigns are the responsibility of the bottler, while national campaigns are responsibility of the upstream firm. BA 3

Go back

Bottler Agreement 1

Go back

Bottler Agreement 1

The Company reserves the right, by giving written notice to the Bottler, to establish and to revise from time to time and at any time, in its sole discretion, the price of the Concentrate, the Authorized Supplier, the supply point and alternate supply points for the Concentrate, the conditions of shipment and payment, and the currency or currencies acceptable to the Company or the Authorized Suppliers. Go back

Bottler Agreement 2

Go back

Bottler Agreement 2 [. . .] It is recognized in this regard that the Bottler may sell the Beverage to wholesalers and retailers and authorize the retail sale of the Beverage at prices which are lower than the maximum prices. The Bottler shall not, however, increase the maximum prices established or revised by the Company at which the Beverage in Approved Containers may be sold to wholesalers and retailers nor authorize an increase in the maximum prices for the Beverage without the prior written consent of the Company. Go back

Bottler Agreement 3

Go back

Data: FTC Documents

Counties where Dr Pepper was bottled by the bottler acquired by Coca Cola Go back DR PEPPER

U.S. DISTRIBUTION Source:CCR FTC’s Complaint, Appendix B.

. ..

•••

EJ OWNERSHIP CCR

Alternative Sets of Fixed Effects (1) β Own

-0.004 (0.005)

(3) log(price) -0.004 -0.016*** (0.005) (0.003)

β DrPepper

0.032*** (0.004)

0.031*** (0.004)

0.042*** (0.002)

0.039*** (0.002)

37,106,832 0.875 Yes No No No

37,106,832 0.882 Yes No No Yes

37,106,679 0.892 No Yes No Yes

37,106,025 0.893 No No Yes Yes

Observations R2 Prod FE Prod × County FE Prod × County × Quarter-of-year FE Store FE

(2)

(4) -0.017*** (0.003)

Notes: Standard errors clustered at the county level in parentheses. *** p < 0.01. Specifications include controls for feature and display, week × parent company FE, and week × county FE.

Price Variation

Sample All 67 oz products All 67 oz products (non-sale prices) Select 67 oz products Select 67 oz products (non-sale prices)

Between store–week 0.401 0.704 0.503 0.869

Within store–week 0.599 0.296 0.497 0.131

Notes: The variance of price is decomposed using the identity pjst = pst + (pjst − pst ), where pjst is the price of product j at store–week (s, t), and pst is the average price at store–week (s, t). The variance of pjst is the sum of var(pst ) (between store–week variation) and var(pjst − pst ) (within store–week variation). The table reports the between and within store–week variation relative to total variance (i.e., var(pst )/var(pjst ) and var(pjst − pst )/var(pjst ), respectively). Select 67 oz products include Coca-Cola, Diet Coke, Pepsi, Diet Pepsi, Dr Pepper, and Diet Dr Pepper.

Closed vs. Quantity-Weighted Prices

Store Product Coca Cola (67 oz) Diet Coke (67 oz) Pepsi (67 oz) Diet Pepsi (67 oz) Dr Pepper (67 oz) Diet Dr Pepper (67 oz)

1 1.49 1.49 1.39 1.39 1.29 1.29

2 1.59 1.59 1.49 1.49 1.59 1.59

3 1.49 1.49 1.39 1.39 1.39 1.39

4 1.49 1.49 1.39 1.39 1.29 1.29

5 1.69 1.69 1.59 1.59 1.59 1.59

Notes: All of these examples correspond to IRI week 1429 (January 15-21, 2007). Each column corresponds to a different store. None of the prices in the table were flagged as a “sale price” in the data.

Is there within-store price variation? Yes! 1

Cumulative Probability

.8

.6

.4

.2

0 0

.2

.4

.6

.8

1

Standard deviation of listed prices

Notes: The standard deviation of price is calculated using the prices of the 67 oz bottles of Coca-Cola, Diet Coca-Cola, Dr Pepper, Diet Dr Pepper, Pepsi, and Diet Pepsi. The figure restricts attention to store–week combinations where none of the prices are flagged as a “sale price.”

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Vertical Integration with Multiproduct Firms: When ...

In 2009 and 2010, PepsiCo and The Coca-Cola Company integrated with some of their bottlers. • Not all areas of the country were affected by vertical integration. • Bottlers bottled Dr Pepper Snapple Group brands ..... Concentrate, the Authorized Supplier, the supply point and alternate supply points for the Concentrate, the ...

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