Quantity Discounts and Capital Misallocation in Vertical Relationships

• Main Author: ONISHI, Ken
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2016
• Subjects: Vertical Relationships; Nonlinear Pricing; Dynamic Models; Economics; Industrial Organization; Transportation
• Online Access: https://ink.library.smu.edu.sg/soe_research/1734; https://ink.library.smu.edu.sg/context/soe_research/article/2733/viewcontent/QuantityDiscounts_VerticalRel_2016_wp.pdf
• Institution: Singapore Management University

I study transactions between aircraft manufacturers and airlines as well as airlines' utilization of their fleet. Aircraft production is characterized by economies of scale via learning-by-doing, which creates a trade-off between current profit and future competitive advantage in the aircraft market. The latter consideration makes large buyers more attractive than small buyers and induces quantity discounts. The resulting nonlinear pricing strategy may distort both production and allocation in favor of large buyers. In the data, there is a negative correlation between the size of aircraft orders and the per-unit price, and a positive correlation between the price paid and the utilization rate of the aircraft model. The pattern in the data suggests that the manufacturers' price discrimination leads to misallocation of aircraft. To assess whether there is an inefficient allocation, I construct and estimate a dynamic model of the aircraft market that includes a model of utilization. Using the estimated model, I conduct counterfactual simulations where I find that uniform pricing increases aircraft production by 10% and total welfare by 1.6%.