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Manufacturer Allowances and Retailer Pass-Through Rates in a Competitive Environment

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Author Info

  • Sang Yong Kim

    (Korea Advanced Institute of Science & Technology, Graduate School of Management, 207-43 Cheongryangri, Dengdaemun, Seoul 130-012, South Korea)

  • Richard Staelin

    (Fuqua School of Business, Duke University, Durham, North Carolina 27708)

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    Abstract

    A commonly held belief has grocery and mass merchandise retailers gaining power relative to the upstream consumer package goods manufacturers. One of the major justifications for this belief is that manufacturers are now giving retailers more side payments such as trade allowances, slotting allowances, etc. However, a number of researchers have shown that these concessions have not translated into increased profit for the retailer relative to the manufacturer. This paper explores, via an analytic model, why one might see retailers getting concessions from the manufacturer without being able to translate them into high profits. We do this by representing the interaction between the channel members as a one-period profit maximizing game where manufacturers decide on how large a side payment (i.e., a concession) to give to each retailer and retailers decide on how much of this side payment to use to promote the manufacturer's product. At the heart of our model is a demand function for each product offering (i.e., a specific brand sold by a specific retailer). This demand function is linear in own and other's prices, but based on empirical evidence is assumed to be nonlinear in the effects of merchandising activities (e.g., short term price discounts, better shelf space, advertising, etc.). Specifically, merchandising effects are modeled with a square root function that also acknowledges most short-term promotional effects result in brand or store switching versus increase category volume. The model is composed of six parameters. These are the inherent popularity of the brand at a particular outlet, own price sensitivity, cross (but within the store) price sensitivity, customer's sensitivity to within store promotion activities, customer's sensitivity to between store promotional activities, and the degree to which promotional activities yield incremental product category sales. We use our underlying demand formulation to find the equilibrium solution to the full information, Stackelberg leader game for different store and brand loyalty environments as captured by our six parameters. These parameters are chosen based on empirical evidence to span possible market conditions that each channel member might have. Our findings and modeling efforts should be of interest to analytic channel modelers and scholars interested in the mass merchandising and grocery store industries. For a theoretical point of view we build upon the Case 4 model of Lee and Staelin (1997) to allow for promotional activities. From a substantive point of view we show that manufacturers will freely give retailers side payments even though they know these retailers will pocket a substantial portion of this concession. Moreover, we identify conditions within our model that lead to larger allowances, lower pass through rates, and lower retail profits; outcomes that are compatible with recent industry trends. In addition, we highlight the difference in effect on profits, prices, etc. of changes in consumers sensitivity to inter-store differences in storewide merchandising activities. One of the more counter-intuitive results of these analyses is that it is in the manufacturer's best interest to help retailers increase their spatial monopoly by decreasing consumers' tendency to cross-store shop because of merchandising activities.

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    File URL: http://dx.doi.org/10.1287/mksc.18.1.59
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    Bibliographic Info

    Article provided by INFORMS in its journal Marketing Science.

    Volume (Year): 18 (1999)
    Issue (Month): 1 ()
    Pages: 59-76

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    Handle: RePEc:inm:ormksc:v:18:y:1999:i:1:p:59-76

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    Related research

    Keywords: Channel Management; Trade Promotions; Nash Equilibrium;

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    Citations

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    Cited by:
    1. Daniel Levy & Haipeng Allan Chen & Sourav Ray & Mark Bergen, 2004. "Asymmetric Price Adjustment "in the Small:" An Implication of Rational Inattention," Macroeconomics 0407012, EconWPA, revised 11 May 2005.
    2. Kunter, Marcus, 2012. "Coordination via cost and revenue sharing in manufacturer–retailer channels," European Journal of Operational Research, Elsevier, vol. 216(2), pages 477-486.
    3. Aust, Gerhard & Buscher, Udo, 2012. "Vertical cooperative advertising and pricing decisions in a manufacturer–retailer supply chain: A game-theoretic approach," European Journal of Operational Research, Elsevier, vol. 223(2), pages 473-482.
    4. Peter Boatwright & Sanjay Dhar & Peter Rossi, 2004. "The Role of Retail Competition, Demographics and Account Retail Strategy as Drivers of Promotional Sensitivity," Quantitative Marketing and Economics, Springer, vol. 2(2), pages 169-190, June.
    5. Noriaki Matsushima & Akira Miyaoka, 2013. "Who benefits from resale-below-cost laws?," ISER Discussion Paper 0875, Institute of Social and Economic Research, Osaka University.
    6. Sourav Ray & Haipeng Chen & Mark Bergen & Daniel Levy, 2005. "Asymmetric Wholesale Pricing: Theory and Evidence," Macroeconomics 0503021, EconWPA.
    7. Karray, Salma, 2011. "Effectiveness of retail joint promotions under different channel structures," European Journal of Operational Research, Elsevier, vol. 210(3), pages 745-751, May.
    8. Yang, Jing & Xie, Jinxing & Deng, Xiaoxue & Xiong, Huachun, 2013. "Cooperative advertising in a distribution channel with fairness concerns," European Journal of Operational Research, Elsevier, vol. 227(2), pages 401-407.
    9. Srinivasan, S. & Pauwels, K.H. & Hanssens, D.M. & Dekimpe, M.G., 2002. "Do Promotions Benefit Manufacturers, Retailers or Both?," ERIM Report Series Research in Management ERS-2002-21-MKT, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    10. Buckinx, Wouter & Van den Poel, Dirk, 2005. "Customer base analysis: partial defection of behaviourally loyal clients in a non-contractual FMCG retail setting," European Journal of Operational Research, Elsevier, vol. 164(1), pages 252-268, July.
    11. SeyedEsfahani, Mir Mehdi & Biazaran, Maryam & Gharakhani, Mohsen, 2011. "A game theoretic approach to coordinate pricing and vertical co-op advertising in manufacturer-retailer supply chains," European Journal of Operational Research, Elsevier, vol. 211(2), pages 263-273, June.
    12. Aust, Gerhard & Buscher, Udo, 2014. "Cooperative advertising models in supply chain management: A review," European Journal of Operational Research, Elsevier, vol. 234(1), pages 1-14.
    13. Karray, Salma, 2013. "Periodicity of pricing and marketing efforts in a distribution channel," European Journal of Operational Research, Elsevier, vol. 228(3), pages 635-647.

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