Working Paper: CEPR ID: DP5365
Authors: Roman Inderst; Christian Wey
Abstract: We challenge the view that the presence of powerful buyers stifles suppliers' incentives to innovate. Following Katz (1987), we model buyer power as buyers' ability to substitute away from a given supplier and isolate several effects that support the opposite view, namely that the presence of powerful buyers induces a supplier to invest more in cost reduction. In contrast to negotiations with smaller buyers, the outcome of negotiations with large buyers is fully determined by their more valuable alternative supply option. This increases the supplier's incentives to reduce marginal costs, both as the supplier receives a larger fraction of the thereby generated incremental profits and as this makes buyers' alternative supply option less valuable. The latter effect is due to downstream competition between buyers and, as we show, is also stronger the larger and thus the more powerful buyers are.
Keywords: buyer power; investment incentives; merger
JEL Codes: D43; L12; L41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| larger buyers (L81) | suppliers invest more in cost reduction (G31) |
| larger buyers (L81) | higher share of incremental profits for suppliers (D26) |
| higher share of incremental profits for suppliers (D26) | suppliers invest more in cost reduction (G31) |
| larger buyers (L81) | greater supplier investment (G31) |
| larger buyers (L81) | reduced value of alternative supply options for buyers (D46) |
| reduced value of alternative supply options for buyers (D46) | increased supplier profits (D21) |
| larger buyers (L81) | better negotiation outcomes (C78) |
| better negotiation outcomes (C78) | suppliers invest more in cost reduction (G31) |