Asymmetric input contracts under price leadership

This paper considers a vertically related industry where an upstream supplier simultaneously and independently negotiates linear tariffs with two asymmetrically capacity constrained downstream retailers endowed with (possibly) asymmetric bargaining powers over the purchase of an input. We introduce price leadership as the type of downstream competition. An increase in the upstream supplier’s bargaining power toward the large firm induces a positive externality on the small firm’s tariff. We also obtain that, a priori the small firm may end up (i) demanding a larger stock of the input and (ii) paying less for it. Our model also proves useful to show that the well-known countervailing buyer power hypothesis could not hold because an integrated downstream firm might negotiate a better input price without any pass-through to the final consumers. We mainly relate our analysis to the UK grocery market and to the recent empirical evidence regarding its functioning.