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Abstract
The increasing importance of services in industrialized economies is reflected in the relative importance
of service in product offerings at the retail level. Yet, typical economic studies account
only for physical product attributes in models of product differentiation even when conducted
with retail data. In U.S. food retailing, the issue is very important as raw farm products account
for only 19% of every dollar the consumer pays for food, most of the remaining going to services
that do not transform the product but that add consumer utility and cost. In this paper, we
examine this issue using the case of breakfast cereals in Boston in the context of upscale retail
services provided by supermarkets.
Focusing on ready-to-eat cereals (RTECs) allows us to look more closely at the role of services
in product market equilibrium. First, supermarket retail services go beyond the obvious single
product exchange function as consumers value services and suppliers incur a cost in providing
them. Given that retail services affect the primitives of the market, i.e., demand and costs, they
also affect retail prices. Third, regardless of inter-supermarket variation in costs and prices, the
issue of who’s got the power in the RTEC vertical market channel has been a hotly debated issue.
The usual suspect has been the RTEC manufacturing industry, although previous studies
have not modeled the retailing stage of the marketing channel to determine their relative contribution
to channel price-cost margins and the role of retail services. The conventional wisdom is
that the RTEC manufacturing industry mutes price competition and engages in non-price competition
(Schmalensee, 1978; Scherer, 1982).
This paper contributes to the literature in two important ways. First, it extends the Berry, Levinsohn
and Pakes (BLP, 1995) model of market equilibrium to ready-to-eat cereals (RTECs) in
Boston by including consumer taste for supermarket retail services. Second, it tests and compares
alternative pricing games between manufactures and supermarkets in order to assess their
relative market power.