Buyer Power and Quality Improvements

This paper analyses the sources of buyer power and its e¤ect on sellers’ investment in quality improvements. In our model retailers make takeit-or-leave-it o¤ers to a producer and each of them obtains its marginal contribution to total pro…ts (gross of sunk costs). In turn, this depends on the rivalry between retailers in the bargaining process. Rivalry increases when the retailers are less di¤erentiated and when decreasing returns to scale in production are larger. The allocation of total surplus a¤ects the incentives of the producer to invest in product quality, an instance of the hold-up problem. An increase in buyer power not only makes the supplier and consumers worse o¤, but it may even harm the retailers, that obtain a larger share of a smaller surplus. A repeated game argument shows that e¢ cient quality improvements can be supported as an equilibrium outcome if producer and retailers are involved in a long-term relationship.