Prices, profits, and pass-through of costs along a supermarket supply chain: bargaining and competition

In this paper we present an empirical study of a supermarket supply chain to understand the determinants of prices and profits enjoyed by farmers, processors, and supermarkets. We study the liquid milk market which has seen much controversy about both the distribution of rents and the mechanisms firms have used to influence the distribution. We discuss insights from a series of interviews we conducted with executives and farmer representatives. Our interviews suggest a model in which the farmer's price is determined mainly by the sterling value of international commodity prices; the retail price is determined by marginal costs and the intensity of supermarket competition; and the wholesale price is determined in private bilateral negotiations between retailers and processors which are characterized by well-informed agents and a high level of efficiency. We present a simple theoretical model that captures these features and bring it to data on supply chain prices for the period 1994-2014. We find that over this period there has been great variation in the intensity of retail price competition and in the sterling value of international commodity markets, which together result in large changes both to the overall surplus in the supply chain and to its distribution between farmers and the other firms. After farmers have been paid the sterling value of international commodity prices, the profit that remains to be split between processors and retailers mostly goes to supermarkets, because of competition between processors