Gray, Michael (1996) Concentration dynamics and bargaining power: a theory of two-dimensional competition in the agri-food complex. PhD thesis. http://theses.gla.ac.uk/5021/ Copyright and moral rights for this thesis are retained by the author A copy can be downloaded for personal non-commercial research or study, without prior permission or charge This thesis cannot be reproduced or quoted extensively from without first obtaining permission in writing from the Author The content must not be changed in any way or sold commercially in any format or medium without the formal permission of the Author When referring to this work, full bibliographic details including the author, title, awarding institution and date of the thesis must be given Glasgow Theses Service http://theses.gla.ac.uk/ [email protected] 056689iiJllml1 CONCENTRATION DYNAMICS AND BARGAINING POWER: A THEORY OF TWO-DIMENSIONAL COMPETmON IN THE AGRI-FOOD COMPLEX BY MICHAEL GRAY BSc THESIS SUBMI'ITED FOR THE DEGREE OF Ph.D FACULTY OF SCIENCE DEPARTMENT OF AGRICULTURE UNIVERSITY OF GLASGOW CONDUCTED AT SAC AUCHINCRUIVE AUGUST 1996 @Michael Gray (1996) M. Gray 1996 2 ABSTRACT This thesis attempts to explain vertical market interaction within the food chain from a new perspective. It takes a two-stage game-theoretic framework from industrial organisation literature, and extrapolates this into the area of bargaining relationships. In turn, the inter-sectoral paradigm developed is applied to the specific area of agricultural marketing and the conventional wisdom of cooperatives is challenged. The resulting model allows new insights into such issues as countervailing market power, the dynamics of market structure and competition policy. Although the principles have been developed within the context of the U.K. food chain, they are of wider relevance. The conceptual framework developed underlines that in studying bargaining relationships and market structures the economic concept of equilibrium may be better replaced with a broader game-theoretic understanding of the market process. Table of Contents List of Tables 9 List of Figures . .. 11 Acknowledgements 12 Chapter 1 INTRODUCTION......................... 13 1.1 Market Structure and Market Power as a Two-Way Process. 13 1.2 The Conventional Picture of Agricultural Marketing ..... 15 1.3 Structure of the Food Industries and a Relevant Economic Paradigm 23 1.3.1 The Operation of Bilateral Oligopoly and Countervailing Power 24 Retail Sector . .. 24 Food Manufacturing Sector. .. 26 Producer Sector . .. 30 1.4 Structure of Thesis . .. 31 Chapter 2 THE CENTRAL THEME AND FRAMEWORK 39 2.1 Bilateral Oligopoly and Game Theory 39 2.2 The Game Theoretic Framework 40 2.2.1 Quantity versus Price Strategies - The Coumot and Bertrand Models 41 2.2.2 Interdependence - Models of Conjectural Variations. 43 2.2.3 The Market Process - Austrian Economics and Game Theory 47 2.2.4 Dynamic Rivalry - Repeated Oligopoly Games 51 Finitely Repeated Oligopoly Games . .. 52 Infinitely Repeated Oligopoly Games . .. 54 M. Gray 1996 4 Price Setting Supergames . .. 57 Supergames with Imperfect Monitoring 60 2.2.5 Sunk Costs - Two-Stage Games 61 2.3 Applications of Game Theory to Understanding the Structure of the Food Chain . .. 64 2.3.1 Conjectural Variations 65 2.3.2 Supergame Theory 65 2.3.3 Two-Stage Games . .. 68 2.4 Conclusions.............................. 73 Chapter 3 BILATERAL OLIGOPOLY AND CONCENTRATION THE RETAIL SECTOR 75 3.1 Introduction.............................. 75 3.2 The Process of Retail Concentration 75 3.2.1 The Influence of Legal Structures on Retail Concentration 78 3.2.2 Manufacturer Price Discrimination and Retail Concentration 80 3.2.3 Selling Strategies and Retail Concentration. .. 84 3.2.4 Two-Stage Competition and Retail Concentration. .. 86 3.2.5 New Entry and the Discount Sector . .. 90 3.2.6 The Own-Label Strategy. .. 93 3.3 Retailer/Manufacturer Relationships .. .. 97 3.3.1 Vertical Partnerships . .. 97 3.3.2 The Growth of Buying Alliances. .. 99 3.3.3 Vertical Integration . 100 3.3.4 Vertical Restraints 101 3.4 Summary............................... 106 M. Gray 1996 5 Chapter 4 BILATERAL OLIGOPOLY AND CONCENTRATION THE FOOD MANUFACTURERS 108 4.1 Introduction.............................. 108 4.2 Sunk Cost and Market Structure 108 4.3 Contradicting Views on Concentration Dynamics 115 4.4 Analysis of Manufacturing Sectors 120 4.4.1 Advertising Insignificant - Slaughtering and Meat Processing 124 4.4.2 Advertising Intensive Industries with Low Own-Label Penetration - Soft Drinks and Pet Foods 126 4.4.3 Advertising Intensive Industries with High Own- Label Penetration - Frozen Foods and Fish Processing 131 4.5 Summary................................ 136 Chapter 5 MARKET POWER AND PRODUCER COOPERATIVES FREE MARKET SITUATIONS 143 5.1 Introduction 143 5.2 The Traditional View of Countervailing Power. .. 144 5.3 Asymmetry between Buyers and Sellers 148 5.4 Distinguishing between the Firm and the Agricultural Cooperative . 152 5.5 Forms of Agricultural Marketing 155 5.5.1 Agricultural Cooperatives 156 Marketing-only Cooperatives . 158 Vertically Integrated Cooperatives. .. 164 5.5.2 Vertical Partnerships 167 5.6 Summary 181 M. Gray 1996 6 Chapter 6 MARKET POWER AND PRODUCER COOPERATIVES REGULATED MARKET CONTEXT . 183 6.1 Introduction 183 6.2 The U.K. Dairy Industry 184 6.3 Market Structure and Supply Seasonality Under the Scheme 186 6.3.1 The Liquid Sector . 188 6.3.2 Dairy Product Sector 190 6.3.3 Seasonality of Milk Production 194 6.4 Deregulation and the Market Structure 196 6.4.1 Changes in Product Portfolio 199 6.5 Milk Marketing Structures 202 6.5.1 Large Horizontal Marketing-Only Cooperatives 202 6.5.2 Vertically Integrated Cooperatives 205 6.5.3 Vertical Partnerships 206 Individual Supply Contracts 206 Group Marketing . 208 Vertical Partnerships with Primary Product Differentiation 212 6.6 Summary 214 Chapter 7 CONCLUSIONS 217 7.1 Overview . 217 7.2 The Two-Dimensional Model 218 7.2.1 Traditional Approaches to Market Power 219 7.2.2 The Need for a Holistic Approach 220 7.2.3 Endogenous Sunk Cost Industries 221 Downstream Horizontal Interaction . 221 Upstream Horizontal Interaction . 224 Vertical Competition . 225 Countervailing Power 228 M. Gray 1996 7 7.2.4 The Two-Dimensional Model and Dynamics of Market Structure 229 7.2.5 Cross-links in the Two-Dimensional Model 232 7.2.6 Non-Linear Contracts in the Two-Dimensional Model 234 7.2.7 Exogenous Sunk Cost Industries .. 236 7.2.8 The Necessary Conditions for Countervailing Power 238 Countervailing Power in Non-Spatial Markets 240 Countervailing Power in Spatial Oligopsony . 244 7.3 Dynamic Two-Dimensional Competition and the Market Process . 247 7.3.1 Modem Austrian Criticisms of the Equilibrium Approach . 248 7.3.2 The Two-Dimensional Model and the Austrian Approach 249 7.3.3 Differences with the Austrian Approach 251 7.4 Competition Policy 252 7.5 Areas for Further Research . 260 7.6 Summary 262 Appendix I ANALYSIS OF FOOD MANUFACTURING CONCENTRATION 264 The Industry Data 264 Analysis of Food Manufacturing Sectors 271 Advertising Insignificant 271 Advertising Intensive Industries not Undermined by Own-Label 279 Advertising Intensive Undermined by Own-label Penetration 285 M. Gray 1996 8 Appendix II AUCTION SYSTEMS FOR MARKETING MILK 290 Introduction 290 Theory of Auctions 292 Multiple Auctions 295 Auction Rules in Comparison 296 Buyer Collusion 298 List of References . 302 M. Gray 1996 9 List of Tables Table 1.1: Sector Shares of Grocery Market 1950-1987, Percent. .. 25 Table 1.2: Four-Firm Sales Concentration . .. 27 Table 3.1: A checklist for the potential of manufacturer power . .. 76 Table 3.2: Advertising Expenditure at Current Prices by Operator, 1988-1993 (£'000) 88 Table 3.3: Growth of Discount Grocery Outlets in the UK, 1989-1997, Number of Outlets . .. 91 Table 3.4: Own-Label Share of Packaged Grocery Turnover by Operator, 1993, Percent 95 Table 3.5: IGD Retail Market Shares, 1989-1993, Percent 96 Table 3.6: Characteristics of U.K. Legislation on Vertical Restraints relating to the Food Sector . 105 Table 4.1: Hypothesized Effects of Retail Multiples on Manufacturing Sectors 121 Table 4.2: Market Share of Top Five Firms Measured as Percentage of Gross Output 122 Table 4.3: Number of Enterprises in the 1-99 Employee Size Group 123 Table 4.4: Key Aspects of Sectors to be Studied 123 Table 4.5: U.K. Meat Processing Sector, No. of Enterprises, 1989-1992 . 124 Table 4.6: Breakdown of U.K. Soft Drink Consumption 127 Table 4.7: Own-Label Penetration in Soft Drinks, 1992 128 Table 4.8: Own-Label Penetration in Pet Foods, 1993, Percent 130 Table 4.9: Retail Sales in Quick Frozen Foods, Market Shares 132 Table 4.10: Market Share for Frozen Vegetables, % of value of market, 1987-93 134 Table 4.11: Advertising Expenditure on Fish, 1988-92 (£'000) 135 Table 5.1: Generalised Di.{JerencesofCAC and CSC Organisations 157 Table 5.2: Costs Associated with Vertical Market Structure 173 M. Gray 1996 10 Table 6.1: Size Distribution of Liquid Milk Processors England & Wales Milk Marketing Board area 190 Table 6.2: Average Return For Milk, End-Use Prices 1987-88, pence per litre 192 Table 6.3: Imports of High Value Products Into the U.K. 193 Table 6.4: Percentage of Milk Supplies to Liquid and Producer Prices, 1992 200 Table 6.5: Summary of the Various Methods of Milk Marketing and their Rationale 212 Appendix Table 1: Cs as Percentage of Gross Output .. 265 Appendix Table 2: Number of Enterprises in the 1-99 Employee Size Group 265 Appendix Table 3: Hypothesis Classification of Food Manufacturing Sectors 269 Appendix Table 4: Hypothesis Classification of Food Manufacturing Sectors 271 Appendix Table 5: Market Shares for Sugar Confectionary, 1992 . 281 Appendix Table 6: Pasta Own-Label Penetration, 1992 .