Vertical agreements: an empirical price analysis of beer

Van Passel Steven

1
& Wauters Erwin
2
1
Hasselt University, Department of Business Economics, Agoralaan Building D, B-359 Diepen!ee", Belgium
#
$%&', (ocial (ciences Unit, Burg) &an *ans!erg+elaan 115, B-9,# -erel!e"e, Belgium

Abstract
In several countries worldwide, the market structure of the brewery industry is
one of a limited and decreasing amount of producers. Such highly concentrated
production is most often accompanied by signifcant market power. Furthermore,
a common practice of market behaviour is vertical coordination where frms may
decide to combine technologically diferent production processes, distribution
processes, marketing processes or any other economic process. In fact, the
extent of vertical coordination may range along a continuum from a spot market,
contracting, strategic alliance, formal cooperation to full vertical integration.
common strategy of breweries is to conclude exclusivity agreements with bars.
!his paper reports on a study investigating the impact of vertical agreements
between beer producers and beer selling bars on the beer price. "uantitative
analysis of vertical agreements was performed using survey data of #elgian bars.
$xecuting a principal component analysis we found four relevant components%
component & 'bar location, bar density(, component ) 'bar ownership, exclusivity
agreement(, component * 'bar type( and component + 'beer turnover(. !o
determine the impact of these components on the beer price, a regression
analysis was performed. !he results show that the beer price is determined by
bar location and bar type. ,e found no impact of existing vertical agreements
between brewers and bars on the beer price. !his indicates that other aspects
such as bar location and bar type are more important to determine the beer price
than the existence of vertical agreements.
-ey.words% vertical integration, vertical agreements, price analysis, brewery
industry
&
1. Introduction
!he brewing industry has become a global business consisting of several
multinational companies. !here is an ongoing process of concentration
with a decrease in the number of breweries and an increase of production
capacity. !his hori/ontal integration process, whereby breweries take over
other breweries, started already in the &0
th
century and is still ongoing
today. 1urrently the global market is dominated by a limited amount of
multinational breweries2 nevertheless there still exists a large amount of
local and regional breweries. !he ma3ority of these smaller companies
focus on the production of diferent varieties of ale 'or specialty beers(.
!he global beer producers rather focus on the production of lager where as
a conse"uence the market concentration is higher. !his study has its focus
on the lager beer market.
4ighly concentrated production may result in the presence of signifcant
market power. !heoretically, the beer market can be described as an
oligopolistic market, where a small group of frms operate in a market with
substantial barriers to entry. !here exist several possible reason for a
market structure to be characteri/ed by a high concentration with very few
large frms dominating the industry. First, the existence of economies of
scale create incentives for frms to grow. !he larger the scale of
production, the lower the average variable costs of beer production.
Second, frms often grow by buying out rivals, by merging with them, with
the aim of reducing competitive behavior and gaining larger proft
margins. s in many global industries, the answer is probably that partly
the increase in si/e comes from the e5ciencies of large scale and scope,
and partly from the desire of frms to create market power by growing
large. n important and highly relevant issue is the "uestion whether
oligopolistic companies use their competitive energies to improve their
products and production processes, rather than merely to erect entry
barriers.
6ertical agreements 'or exclusivity agreements( between brewers and bars
can serve as a strategy to hamper the entrance of new breweries. widely
used argument is that breweries would use their market position to reali/e
7excessive8 profts by increasing the beer price through bar ownership and
vertical agreements. !o investigate the impact of vertical agreements,
profound empirical research is necessary. For instance, the existence of
such vertical exclusivity contracts are often blamed for artifcially raising
beer selling prices. !his paper contributes to the empirical literature on
this issue investigating the impact of
vertical agreements between beer producers and beer selling bars on the
beer price.
)
2. Beer market structure and vertical integration
naly/ing market structure and market behavior is essential to investigate
the impact of companies on 'consumer and producer( welfare. 9arket
structure refers to the type of market in which frms operate. #reweries do
not operate in perfectly competitive markets, because the number of
competing frms is too small 'especially if you focus on the lager market(.
simplistic measure to estimate potential market power is the
concentration ratio. For example the 1* ': the turnover of the largest
three enterprises as a ; of the turnover of the sector( of the #elgian beer
market was <.=+ in )<<<, indicating an oligopolistic market. similar
oligopolistic market structure can be found in the ma3ority of countries
worldwide '#enson.rmor et al., &000(.
>ligopolistic markets can be related to a process of creative destruction
'Schumpeter, &0+)(, where oligopolists face strong competition from
existing rivals and cannot aford the more relaxed life of the monopolist.
#ut at the same time, oligopolists can keep a good share of the profts that
they earn from their innovative activity. !he public challenge is to keep
oligopolistic companies competing rather than colluding. n important
characteristic of oligopolies is the existence of entry barriers, these
impediments that prevent entry can have a negative impact on total
welfare. >n the other hand, Schumpeter '&0+)( argues that entry barriers
are not a serious problem in the very long run, because new companies
can for example circumvent entry barriers by developing similar products
where existing companies have no entry protection. ?evertheless, on the
short and even medium run, entry barriers deserve our attention.
!heoretically, there are several ways to create entry barriers. ?atural
barriers can arise as a result of economies of scale. nother possibility is
the creation of policy.created barriers by diferent government levels 'e.g.
patent laws, licenses(. 1ompanies can create a large amount of diferent
brands, to decrease the market share available to a new frm entering with
a single new product. Furthermore, companies can also create entry
barriers by imposing signifcant fxed costs on entrants '@AB, advertising
costs,C(. lso vertical integration can be used as a strategy to hamper the
entrance of new companies.
*
,ithin the brewery industry, a practice of market behavior is vertical
coordination where frms may decide to combine technologically diferent
production processes, distribution processes, marketing processes or any
other economic process. In fact, the extent of vertical coordination may
range along a continuum from a spot market, contracting, strategic
alliance, formal cooperation to full vertical integration. common strategy
of breweries is to conclude so.called vertical agreements with bars or
pubs. !he tied pubs difer on several dimensions, including the ownership
of the pub, the authority to set the retail price, and the existence of fxed.
rental fees 'Slade, &00=(. >n the #elgian beer market, there exist two
important forms of contractual forms% 'i( loan agreements and 'ii( lease or
sublease agreements. #oth vertical agreements contain an exclusive.
purchasing contract or a non.compete obligation, forcing the bars to serve
exclusively the company8s beer. ?ote that the contractual terms can difer
'also depending on the total market share of the brewery(.
,ithin the context of vertical integration, it is important to understand who
is competing with whom and in what sense. general overview of the
#elgian beer market chain is depicted in fgure &. !he ma3ority of the beer
production is distributed to retail and catering 'hotels, restaurants and
bars(. #ars can purchase directly from their brewers or from beer
merchants. >nly a very limited amount of beer is directly distributed from
brewer to consumer. !he share of beer consumption at home 'retail( is
increasing and already +<; of total beer consumption is bought in shops
and supermarkets 'retail(. !he amount of beer consumption in catering
still accounts for more than D<; of total beer consumption.
+
Figure &% the chain from barley farmer to beer consumer.
>ur research only focuses on the market link between catering 'and more
specifc bars or pubs( and the brewery industry 'the grey arrow in fgure
&(.
#y concluding vertical agreements 'or exclusivity contracts(, breweries try
to circumvent possible free.rider problems, hold.up problems and credit
market imperfections. 9oreover, such vertical agreements have the aim to
increase uniformity and "uality standardi/ation and to beneft from
economies of scale. >n the other hand, vertical agreements can result in
exclusion, creation of barriers to entry for new players on the pub market,
decreasing competition, , etcC n often heard disadvantage is that such
exclusivity contracts positively afect beer selling price in bars.
lthough, the choice of vertical market structure is normally endogenous
'Slade, &00=(, we empirically investigate the relationship between brewers
and bars. In this way, this research contributes to the discussion about the
possible impact of vertical agreements on consumer welfare. 9ore
specifc, the research ob3ective is to empirically test the impact of the
existence of vertical agreements on the beer price.
3. Methodology
D
In a frst research stage, several key actors such as bar managers,
association representatives, producers were interviewed to collect the
necessary background information.
3.1 Data
!he research population are the #elgian bars. In )<<&, there were )D +&+
bars in #elgium '?IS, s.d.(. !he survey sample consists of )D< bars,
representing &; of all #elgian bars. !o sample the population, we opt for
stratifed sampling and sampled each subpopulation independently. ,ithin
the selected diferent #elgian provinces 'as indicated in table &(, four
diferent categories of municipalities were described% 'i( the biggest city,
'ii( other cities with more than D< <<< residents, 'iii( municipalities with &D
<<< E D< <<< residents, 'iv( municipalities with less than &D <<< residents.
In the largest cities, &F randomly selected bars 'using alphabetical lists(
were selected, while in the other categories respectively =, + and ) bars
were selected. In this way, the research takes into account the fact that
there are more bars in urban areas. ?ote that in each province one city
was selected in category 'i( and 'ii( and depending on the number of
municipalities in each province between + and G municipalities in each
province in both categories 'iii( and 'iv(.
!able &% Sample stratum
Province Number of
bars
eighting
factor
Number of bars in
sam!le
ntwerp * 0G< <.)) DD
Flemish #rabant H
#russels capital
region
+ FG< <.)) DD
$ast Flanders * =0* <.)) DD
,est Flanders + )&) <.)) DD
Iimburg ) <=D <.&) *<
!otal &= =*< & )D<
!otal #elgium )D +&+
Source% 1## 's.d.(
!he data collection was performed by observation and by "uestioning )D<
bar owners during the beginning of )<<). Inspired by literature and
"ualitative interviews with key informants, we selected several variables
with a possible impact on the beer price such as bar type, bar location, bar
density, bar turnover, bar ownership and the existence of an exclusivity
agreement. n overview of the indicators and variables can be found in
table ). ?ote that only a limited amount of variables were gathered by
interviewing the bar owner 'only unobservable variables such as bar
ownership, exclusivity agreements and turnover(. n advantage of
measuring by direct observation is a higher response rate and a lower
measurement error. In the exceptional cases where the bar owner or bar
keeper refused to cooperate or were not able to cooperate, the closest bar
nearby was selected as an alternative observation. !o support the
interviewers and to guarantee consistent data collection, a manual was
F
constructed with photographs and a brief description of the diferent bar
types and bar locations.
!able )% >verview of research variables
Indicator "ariable #ncoding
#ar location 1ity centre < or &
1ity < or &
1ity border < or &
@ural centre < or &
1ountry < or &
#ar density #ar densityJ&K &2)2* or +
#ar type @egular bar < or &
Lrban bar < or &
Mouth bar < or &
1lub bar < or &
Nrovince ntwerp < or &
Flemish #rabant 'H
#russels(
< or &
$ast Flanders < or &
,est Flanders < or &
Iimburg < or &
#ar turnover mount hectolitre 'hl( lager & : less then )<< hl Oyear
) : between )<<.*<< hl
Oyear
* : between *<<.+<< hl
Oyear
+ : between +<<.D<< hl
Oyear
D : more then D<< hl Oyear
share of beer in total
turnover
share beer & : < E +<; of turnover
) : +< E DD; of turnover
* : DD E G<; of turnover
+ : G< E =D; of turnover
D : =D E &<<; of turnover
#eer diversity #eer diversity ?umber of diferent beer
brands sold
#ar ownership >wner < or &
$xclusivity agreement $xclusivity agreement < or &
Iager price Iager price Nrice 'P(
J&K #ar density was measured as no bars '7&8(, one to three bars '7)8(, several bars '7*8(
and a ma3ority of bars within walking distance
3.2 $nalysis
!o analy/e the impact of vertical agreements on the lager price diferent
regression models were constructed with the dependent variable 'y( the
lager price and with several variables as independent variables 'exclusivity
agreement, turnover, bar type, bar location,C(.
#eer price is modeled using a multiple linear regression model using cross.
sectional data%

1
K
i k ik i
k
y x
=
= + +

'&(
G
with y
i
as the dependent variable, x
ik
as - independent variables, Q
<
and Q
k
are -H& unknown parameters to be estimated, R
i
is a two.sided
independent and identically distributed error term.
!o further improve the empirical analysis, we performed a principal
component analysis. In this model, we frst executed a principal
component analysis to reduce the data to useful basic dimensions. In a
second step, a regression analysis was executed only using the basic
dimensions and still keeping the relevant information. In this way, possible
correlation problems between the amount of variables can be avoided.
Nrincipal component analysis involves a mathematical procedure that
transforms a number of possibly correlated variables into a smaller
number of uncorrelated variables called principal components. It can be
described as an orthogonal linear transformation that transforms the data
to a new coordinate system such that the greatest variance by any
pro3ection of the data comes to lie on the frst coordinate 'called the frst
principal component(, the second greatest variance on the second
coordinate, and so on. s rotation method, a varimax with -aiser
normali/ation and a eigenvalue boundary of one is used.
%. &esults
%.1 Descri!tive statistics
,e found that in )<<) only *F; '0< bars in our sample( of #elgian bars
were independent, most other bars had exclusivity agreements or were
owned by brewers or beer merchants. *0 bars '&D.F;( had agreements
with beer merchants, while &)& bars '+=.+;( had vertical agreements with
breweries. !he minimum beer price 'lager beer( was <.G+ $uro while the
maximum beer price was ).+= $uro. !he average beer price was &.&0
$uro. !he distribution of the beer price of all )D< bars in our sample is
shown in fgure ).
=
Figure )% 4istogram of the lager price
%.2 #m!irical analysis
!able * and + show the results of the diferent regression analysis. !he frst
regression shows that bar type, bar location, province and the share of
beer in the total turnover are important determinants of the beer price in
pubs. @egression & shows clearly that the price in urban, youth and club
bars are signifcant higher then in regular bars. Further, we see that the
price in city bars is higher than the price in city borders, rural centers and
the country side, and lower than in city center bars. ,e also see signifcant
price diferences between provinces. Furthermore, regression & in table *
shows that the share of beer in the total turnover has a signifcant
negative impact on the beer price, indicating higher beer prices in bars
with a lower share of beer sales. In certain bars, customers can eat snacks
and simple meals together with a higher priced beer. lso, bars that
primarily serve other beverages such as cocktails and wine, but still serve
beer, tend to set higher prices. Finally, we see that there is no signifcant
impact of the exclusivity agreements on the beer price, and a small
positive signifcant impact of ownership, indicating a higher beer price in
independent bars.
!able *% regression analysis 'part I(
"ariables &egression 1 &egression 2 &egression 3
0
'oef. t(value 'oef. t(
value
'oef. t(
value
#ar type
@egular bar . . . . . .
Mouth bar <.&<F ).G=<SSS <.&<G ).G=GSS
S
. .
Lrban bar <.&*= D.+)DSSS <.&*= D.+<+SS
S
. .
1lub bar <.<0+ *.&*0SSS <.<0* *.<=)SS
S
. .
#ar location and density
1ity centre <.<=* ).&*+SS <.<GD &.0*DS <.&<= ).F+*SS
S
1ity . . . . . .
1ity border .<.<&= .<.DDG .<.<&G .<.D&& .<.<*) .<.0&*
@ural centre .<.&)+ .*.=00SSS .<.&)) .
*.=&*SS
S
.<.&*& .
*.0+GSS
S
1ountry .<.&)G .*.)*GSSS .<.&)G .
*.)))SS
S
.<.&*= .
*.*)FSS
S
#ar density <.<&) <.G<+ <.<&= &.<** <.<<0 <.+GD
Nrovince
ntwerp . . . . . .
Flemish #rabant .<.<&+ .<.+=) .<.<<0 .<.*<) .<.<)* .<.G)+
,est Flanders .<.<G* .).+**SS .<.<G& .).*+GSS .<.<DD .&.G++S
$ast Flanders .<.<FF .).&DFSS .<.<F+ .).<0*SS .<.<+< .&.)D&
Iimburg .<.<0= .).GD<SSS .<.<0G .
).F=)SS
S
.<.<FG .&.GG0S
#ar characteristics
mount 4I lager .<.<<+ .<.*FG .<.<<+ .<.+&& .<.<<+ .<.+<G
share beer .<.<** .*.F)GSSS .<.<** .
*.FF+SS
S
.<.<+& .
+.*0FSS
S
#eer diversity .<.<<& .<.0G+ .<.<<& .<.==) <.<<< <.&)*
#ar legal situation
>wner <.<D) &.0*+S <.<D& &.=))S
$xclusivity agreement .<.<&= .<.GD& <.<<* <.&** .<.<) .<.G0<
@T <.+*& <.+)) <.*+0
Bependent variable% beer price 'lager(
S signifcant at &<;, SS signifcant at D;, SSS signifcant at &;
In @egression ) E F 'table * and +(, some variables are left out to investigate the
robustness of the impact of the diferent variables. In this way, the impact of
possible correlation between certain variables 'e.g. location and bar density( can
be studied. For example leaving out the diferent bar location variables, results in
a signifcant impact of bar density on the beer price. naly/ing the diferent
regression models, we can conclude that exclusivity agreements have no
signifcant impact on the beer price. Signifcant beer prices are found in diferent
&<
bar types, in bars with a diferent location, and in bars with a diferent share of
beer sales in their total turnover.
!able +% regression analysis 'part II(
"ariables &egression % &egression ) &egression *
'oef. t(value 'oef. t(
value
'oef. t(
value
#ar type
@egular bar . . . . . .
Mouth bar <.&&= *.<&)SSS <.&)G *.)&*SS
S
<.&<G ).=<0SS
S
Lrban bar <.&DF F.<F0SSS <.&+0 D.FGDSS
S
<.&*G D.+&<SS
S
1lub bar <.<0* *.<)=SSS <.<GG ).D<)SS <.<0* *.&&DSS
S
#ar location and density
1ity centre <.<=0 ).)*&SS . . <.<0F ).=*FSS
S
1ity . . . . . .
1ity border .<.<&& .<.*** . . .<.<)= .<.0<+
@ural centre .<.&&0 .*.F*=SSS . . .<.&*+ .
+.FD0SS
S
1ountry .<.&)= .*.&=*SSS . . .<.&+* .
+.D&GSS
S
#ar density <.<&G <.0D& . . . .
Nrovince
ntwerp . . . . . .
Flemish #rabant .<.<&= .<.DF0 .<.<&F .<.D&* .<.<&D .<.D&D
,est Flanders .<.<=F .).G00SS .<.<G* .).**0SS .<.<G+ .).+G<SS
$ast Flanders .<.<FG .).&*FSS .<.<=* .
).FD+SS
S
.<.<F= .).))DSS
Iimburg .<.<0F .).F<GSSS .<.<=0 .).+<&SS .<.<&< .
).=<)SS
S
#ar characteristics
mount 4I lager .<.<<D .<.+G* .<.<<D .<.+D0 .<.<<+ <.*FF
share beer . . .<.<** .
*.D*+SS
S
.<.<** .
*.F0+SS
S
#eer diversity .<.<<& .<.=)G .<.<<& .&.<D< <.<<& <.0)&
#ar legal situation
>wner <.<D+ &.0=0SS <.<++ &.D00 <.<D+ ).<=)SS
$xclusivity agreement .<.<)D .&.<&G .<.<<0 .<.*++ .<.<&0 .<.G0+
@T <.*00 <.*G< <.+*<
Bependent variable% beer price 'lager(
S signifcant at &<;, SS signifcant at D;, SSS signifcant at &;
&&
!o broaden the empirical analysis, a principal component analysis can be
executed to reduce the amount of variables and to structure the data. In
this way, we can construct diferent independent components and use
these components in a second step regression analysis. ?ote that we frst
redefned certain variables to reduce the amount of dummy variables. !he
variable bar location was created with a range of &.D, representing the fve
diferent locations, the variable bar type was created with a range &.+,
representing the four diferent bar types. !he variable province was
created with a range &.D, representing the fve diferent provinces. In this
way, the variables can be used to measure potential signifcant impact,
but the variables can not be used to explain the direction of the
correlations. s shown in table D, the frst principal component consists of
the variables bar location and bar density, the second principal component
consists of the variables owner and exclusivity agreement, the third
principal component consists of the variable bar type and the fourth
principal component consists of the variable amount 4I lager, indication
the beer turnover.
!able D% !he diferent principal components
"ariables 'om!onent
1 2 3 %
>wner <.&FD <.G=F <.<&< <.<*=
$xclusivity agreement <.<&+ <.=)+ .<.&*G <.<<=
mount 4I lager .<.<*= <.&<G <.&)D <.0<+
share beer .<.+G) <.))) .<.&+* .<.<+&
#ar location <.=++ <.)*+ .<.<F* <<&&
#ar density <.=F< <.)*0 .<.<&+ .<.<<D
#ar type .<.<&< .<.&*& <.GDF <.<&F
Nrovince <.*<F .<.)=0 .<.+F* <.+DD
#eer diversity <.*=+ .<.<D* <.D&D <.)++
$xtraction method% principal component analysis, rotation method% varimax with -aiser
normali/ation
!able F shows the results of the regression analysis with as dependent
variable the beer price and as independent variables the principal
components. !he results confrm the previous regression models that the
beer price is mainly determined by the bar location and bar type. ,e did
not fnd a signifcant impact of the legal and contractual relation on the
beer price.
!able F% @egression analysis of principal components
1oe5cient St. error
1onstant &.&=GS <.<&<
1omponent & 'bar location, bar density( <.&<+S <.<&<
1omponent ) 'owner, exclusivity agreement( <.<&G <.<&<
&)
1omponent * 'bar type( <.<)0S <.<&<
1omponent + 'amount 4I lager( <.<&< <.<&<
?umber of observations )D<
d3 @T <.*<
Bependent variable% beer price2 Ssignifcant at &;
). 'onclusion
!o conclude, we found no impact of existing vertical agreements between
brewers and bars on the beer price. spects such as bar location and bar type are
more important to determine the beer price than the existence of vertical
agreements. !his suggests that the beer selling price in pubs is more determined
by observing the price in competitive bars, then that it is determined by the cost.
s such, independent bars may set the same price as the ma3ority, which are
bars with an exclusivity contract 'loan agreements or lease contracts(, but earn a
higher margin. >n the other hand, it is often said that free bars have higher fxed
costs, since they have loans with external fnancing bodies such as banks.
?evertheless our research does not show that vertical agreements have no
negative market impact but only that they have no impact on the beer price.
!o investigate the relation between vertical agreements and beer price in more
detail, more specifc data is necessary 'e.g. diferent contractual relationships(.
From an econometric point of view, observations during several years 'panel
data( would also improve the soundness of the empirical analysis. !o determine
beer prices, bar managers are more considerate of competing bars8 prices than of
their own direct beer purchase cost. 4ence the inUuence of vertical integration on
the beer price should ideally be investigated using panel data. 4owever, since
data of a beer market without exclusivity contracts does not exist, such analyses
cannot be performed.
&eferences
#enson.rmor, @., Ieibowit/, V., @amachandran, B. &000, Wlobal #eer% ,hat8s on
!apX !he 9c-insey Yuaterly, & '&000(% &&&.&)&.
1##, s.d., Lnion of #elgian #rewers 'http%OOwww.beerparadise.be(
?IS, s.d., #elgian ?ational Institute for Statistics
'http%OOwww.statbel.fgov.be(
&*
Schumpeter, &0+). 1apitalism, Socialism and Bemocracy
Slade, 9.$., &00=. #eer and the tie% did divestitute of brewer.owned public
houses lead to higher beer pricesX !he $conomic Vournal &<=% DFD.F<)
&+