The inverse association between the margins of manufacturers and retailers

The margins of manufacturers and retailers are largely determined by the absolute and relative magnitudes of two cross-elasticities that define the willingness of consumers to switch brands within store and to switch stores within brand. When one of these cross-elasticities is high and the other low, margins of firms at the two stages are inversely associated. This phenomenon is widespread but not universal in industries whose retailing segments are imperfectly competitive, as is typically true. The inverse association is inconsistent with “single stage” models which assume that retailing is perfectly competitive and that the derived demand theorem holds. This article explores the dynamics that produce the negative correlation between margins at the two stages, summarizes the empirical evidence and identifies some important areas in which accepted conclusions should be re-examined in light of this relationship.