promotions), while others are more long- term. National brand producers can react to
private labels by using a product differentiation strategy, or by developing new
products. Similarly, Bazoche, Giraud- Héraud and Soler (2005) suggest that the creation
of higher quality private label is not necessarily detrimental but can increase upstream
incentives to innovate and improve quality.
The possibility that vertical competition can affect positively uptream incentives to
adopt non- price strategies has been noted by Steiner (2004) who confirming a similar
conjecture in Steiner (1987) writes: “[..in] a mixed regimen in which the leading
national brands are effectively challenged by the private labels of the major retailers
[...] creates an environment that retains most- all of the benefits of manufacturers’
brand domination - frequent product innovation, scale economies at both stage and
slim leading national brand retail margins” (p. 122).
But an idea often put forward is that the increasing bargaining power of retailers and
higher vertical competitive pressures can have negative effects on such incentives by
lowering manufacturers’ profits and, as a consequence, making it even more difficult
to finance advertising and R&D. Hence, the negative impact on the non- price strategies
that these expenditures contribute to finance, namely product innovation, horizontal
and vertical product differentiation. There is, indeed, growing concern about the
consequences of buyer power. For instance, a report prepared for the European
Commission suggests that when facing powerful buyers suppliers may “reduce
investment in new products or product improvements, advertising and brand
building” (European Commission, 1999). A recent Federal Trade Commission report
suggests that consumers 'could be adversely affected by the exercise of buyer power in
the long run, if prices to suppliers are reduced below the competitive level and if the
suppliers respond by under- investing in innovation or production (FTC, 2001).
The aim of this paper is to improve our understanding of the consequences of vertical
competition. Contrary to the view of a negative impact of buyer power and vertical
competition on upstream incentives, we show that there are substantial and persistent
incentives to adopt non- price strategies of innovation and differentiation. We do not
develop a formal model. More simply, we provide a simple conceptual framework to
illustrate how in a competitive environment characterized by the presence of vertical
competition, manufacturers may face stronger incentives to adopt innovation and
differentiation strategies than in an environment in which the only dimension of
competition is horizontal.
We build on the two- stage approch developed by Steiner. A key finding of Steiner’s
analysis is that in a dual- stage model there is an inverse relationship between the
strength of a brand and the retailer’ s margin, namely the difference between a brand’ s
retail price and its wholesale (or factory) price. Leading brands yield lower retail
margins than less strong brands. The implication is that manufacturers face greater
incentives to invest in advertising and R&D to establish and increase brand’ s strength
because, in addition to their direct demand- creating effect, the margin- depressing
effect of these strategies leads to incresing returns to advertising and R&D
expenditures.
Building on this literature, we develop a theoretical framework that combines the two-
stage approach developed by Steiner with the notion that in order to create shelf space
for their brands, retailers have to delist some national brands. This allows us to show
the existence of a further mechanism in addition to the one focused by Steiner, which