Buyers: balancing their power?

1. Buyers: balancing their power? Prepared for British Brands Group Helen Jenkins, Managing Director May 22nd 2009

2. What is buyer power? • useful to differentiate between buyer market power and countervailing buyer power • balance: buyer power can lead to lower input prices • if downstream is competitive, the lower price is passed on to consumers; welfare is enhanced • lower input price, but at what cost? Buyer market power the ability to affect (lower) the price of inputs by restricting amount purchased inverse of supplier market power arises from lack of competitive pressures on the buyer individually negotiated discounts Countervailing buyer power ability to bargain with strong upstream supplier arises from the buyer placing a competitive constraint on the upstream supplier enhanced by the buyer’s ability to enter the upstream market or sponsor entry by a third party

3. Harmful buyer power: impact on the upstream • use of dominant position (monopsony or cartel cases) to extract large discounts • can lead to eventual exit of suppliers • long-term incentives to invest and innovate • extraction of large discounts dampens the incentives for investment • Inderst (2007): incentives to innovate may increase to gain bargaining power in negotiations with a large buyer • product range can decrease as result of a downstream merger if merging parties decide to single-source • greater competition between suppliers due to smaller product differentiation • less choice for consumer

4. Harmful buyer power: impact on the downstream • exclusionary behaviour to reduce competition downstream • exclusive agreements between larger retailers and suppliers • raising costs of rivals • waterbed effect • suppliers are forced to charge smaller retailers higher prices to compensate for supplying larger retailers at lower prices • can lead to exit of retailers from the market • unintended consequence

5. UK groceries inquiry • reduction in number of smaller retailers was one of the OFT’s reasons for referral of the study to the CC • is there waterbed effect? • the CC found that the assumptions behind the waterbed effect model did not apply to the UK market for groceries • no evidence was found to support the waterbed effect • other findings • buyer power might be offset by supplier power on most prominent goods • financial viability of suppliers is not under threat • no evidence of decline in investment and innovation • no barriers to entry and expansion for smaller suppliers

6. Assessment of buyer market power • applying standard market power concepts to buyers • concentration measures • number of buyers, buyer concentration ratio, HHI • market definition is important (eg, treatment of self-supply) • elasticity of supply • inverse relationship between elasticity and buyer power • performance measures: price-cost margin • the margin depends on all stages of operations not just market power in upstream • in groceries inquiry the CC examined the size of retailers relative to suppliers; retailers' margins; share of retail price earned by retailers in the supply chain.

7. Countervailing buyer power • seen as positive by competition authorities • use of countervailing buyer power argument to clear mergers Cott/Macaw Own brand soft drinks Direct competitors, c. 70% market share Heinz/HP Branded red and brown sauces Limited overlap Deans/ Stonegate Eggs Direct competitors, c. 60% market share Cleared Cleared Divested

8. Implications for analysis • buyer power cannot be assumed good or bad per se • rule of reason test is applied • short- and long-term effects must be considered • implications for innovation and investment are possible • assessement of buyer power • few accepted measures are available

9. www.oxera.com Contact: Helen Jenkins +44 (0) 1865 253 016helen.jenkins@oxera.com