Tuesday, July 20, 2010

Vertical Separation in the Beer & Wine Industry

Since the end of Prohibition, beer and wine producers have been required by law to sell their products only to wholesalers, who then sell the same product to retail outlet, who sell the product to beer and wine customers. This three-tier distribution system was challenged by CostCo primarily in order to avoid the mandatory 10% mark-ups by wholesalers and retailers, to give greater ability to negotiate price discounts by large purchasers and to purchase the products on credit, instead of for cash.

Economic theory shows that even in the extreme case of monopoly, as firms are able to reduce some of the intermediary sellers that final retail prices will fall and overall consumer surplus increases. CostCo is hoping that the gains will also occur to them in the form of higher profits, which is also predicted from theory.

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