Buyer power and supplier incentives

This paper investigates how the formation of larger buyers affects a supplier’s profits and, by doing so, his incentives to undertake non-contractible activities. We first identify two channels of buyer power, which allows larger buyers to obtain discounts. We subsequently examine the effects of buyer power on the supplier’s incentives and on social welfare. Contrary to some informal claims in the policy debate on buyer power, we find that the exercise of buyer power -even though reducing supplier’s profitsmay often increase a supplier’s incentive to undertake welfare enhancing activities. ∗Corresponding author: London School of Economics, Dept. of Economics, Houghton Street, London WC2A 2AE, UK. E-mail: [email protected]. †Wissenschaftszentrum Berlin für Sozialforschung (WZB), Reichpietschufer 50, 10785 Berlin, Germany; CEPR, London. E-mail: [email protected].