The Collusive Effect of Multimarket Contact on Prices: Evidence from Retail Lumber Markets

In this paper, we investigate whether multimarket contact leads to collusive pricing in the retail lumber market and assess the effect of potential regulation on consumer welfare. In particular, we focus on the competition between Home Depot and Lowe's since they are the main players in retail lumber market. For our analysis, we assemble an original data set of prices and sales in the pressure treated lumber category. We first provide reduced form evidence for the effect of multimarket contact on collusion in pricing strategies by showing a positive and significant correlation between price and multimarket contact. Guided by this evidence we estimate a model, using the Berry, Levinsohn and Pakes (1995) equilibrium framework, that includes both the demand and supply side with conduct parameters which capture the degree of collusion in setting prices. We specify the conduct parameters as a function of multimarket contact, following the framework developed by Sudhir (2001) and Ciliberto and Williams (2014). We find that the conduct parameter for capturing the effect of multimarket contact on collusion is significant and positive, implying that multimarket contact leads to higher prices than those from a competitive Bertrand-Nash equilibrium. Using the model estimates, we conduct a counterfactual analysis to measure the consumer welfare impact due to collusive pricing. We find that consumer surplus in January, 2016 increases by $57.7k and this amounts to $692.4k in a year. To the best of our knowledge, this is the first paper that shows state-level multimarket contact facilitates collusive pricing with implications for consumer welfare. The finding has important policy implications that might suggest the need for monitoring prices in states where retail firms have a greater degree of multimarket contact.