# Oligopolistic producers and retail price wars

Consider an industry with few producers selling differentiated products. The products must be sold through retailers of whom also there are a few and who therefore possess some degree of market power. Each retailer sells the products of all producers.

What might be the reasons for the producers to dislike a price war among the retailers?

With just one producer my guess would have been that the producer would always like a retail price war since a more competitive retail sector would reduce the double-marginalization problem and hence allow the producer to capture more profits. Is this intuition right? And how does moving from monopoly to oligopoly in production change things?

This question comes from a real-world observation. This Diwali (which is to Indian retailers what Christmas is to western ones) there was an intense price war among online retailers in India. In response to this price war, many producers of consumer durables like TVs and cameras made public statements against this price war and actively discouraged consumers from buying from these online retailers by measures such as offering longer warranties for products bought from brick-and-mortar stores.

A simple explanation for this behavior is that this was just to appease the brick-and-mortar stores which still dominate Indian retail.

But could there be a deeper explanation?

One story I could think of was as follows: suppose that the price charged by producers to retailers is not directly observed. Then a retailer price war can make it harder to detect a cut in the producer-to-retailer price. This can cause any implicit price collusion between the producers to break down, something which none of the producers would like to happen.

But I'm sure this is not the only possible explanation.

## 2 Answers

A producer won't always want the retail outlets to compete on price. This is the reason for minimum resale price maintenance. By competing on price, it may be that the retailers competition amounts to something closer to a zero-sum game. Supposing there are some consumers who value something like service, it might be better for joint profits to provide good service and thus bring in new consumers. You might imagine two stores selling electronics. The stores might find it best to cut price to pull the customers away from the other. The producer would rather there be good service, display models, helpful employees, etc to bring in new customers.

Reference: Winter (1993)

• I think this is also called "retail price support" which happens to have a decent Wikipedia page.
– BKay
Jan 14 '15 at 20:34

An even simpler explanation is that the manufacturers were attempting to collude on prices through their media statements. Motta's book Competition Policy, Theory and Practice has a formal analysis in Chapter 6.

Your observation about a monopoly producer are treated in the analysis of intra-brand competition. With two-part tariff contracts, producers can pay retailers a whole-sale price equal to marginal costs $w = c$, and extract the downstream profits through a fixed franchise fee $F$. Motta shows that vertical restraints such as retail price maintenance or exclusive areas imposed by monopoly producers on their downstream retailers are typically welfare enhancing (e.g. promoting customer service, such as in car dealers).

In the case of inter-brand competition, vertical restraints are much more likely to be detrimental to welfare, although case-by-case analyses are required to make any specific statements. Bernheim & Whinston (1985) identify common agency as an indirect mechanism through which competing firms may "sell out" to a single party, thereby creating incentives which generate a collusive outcome. This could apply to your Indian example if retailers would sell brands from multiple manufacturers (e.g. this happens in most electronics stores).