A structural model of cost pass-through: the case of the US yogurt retailing

Abstract

We provide a structural framework for retail cost pass-through based on a neoclassical inverse demand model and retail profit maximization conditions. Unlike previous literature where game-theoretic structures are imposed on cost pass-through, our framework allows for estimating cost pass-through and the degree of market competition simultaneously. Further, our model incorporates potential cross-brand effects representing demand substitution and strategic complementarity effects. Our model supplements the traditional reduced-form approach to pass-through and is applicable in environments, where the lack of brand-level cost data renders reduced-form analysis infeasible. The empirical value of our model is illustrated in an econometric analysis of retail pass-through for national and store brand yogurt. Our results indicate that: (1) market competition has a positive impact on own-brand cost pass-through, especially for national brands, and (2) overlooking cross-brand effects results in biased own-brand pass-through estimates. Finally, we provide a graphical illustration of the relationship between cost pass-through and market competition.