Competitive Package Size Decisions

In the consumer packaged goods (CPGs) industry, consumers base their purchase decisions in part on package size because different package sizes offer different levels of convenience. The heterogeneous preference for package size allows manufacturers to use package size as a competitive tool in order to raise margins in the face of higher production costs. By competing in package sizes, manufacturers may be able to soften the degree of price competition in the downstream market, and raise margins accordingly. In order to test this hypothesis, we develop a structural model of consumer demand, and manufacturers’ joint decisions regarding package size and price applied to supermarket chain-level scanner data for the ready-to-eat breakfast cereal category. While others have argued that manufacturers reduce package sizes as a means of raising unit prices in a hidden way, we show that package size and price are strategic complements – downsizing intensifies price competition, which does not allow manufacturers to raise unit prices through package downsizing. Therefore, package downsizing does not yield a desirable outcome for manufactures. On the other hand, retailers benefit from package downsizing, as it leads to lower wholesale prices, and higher category profits.