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Designing Price Contracts for Boundedly Rational Customers: Does the Number of Blocks Matter?

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Author Info

  • Noah Lim

    ()
    (C. T. Bauer College of Business, University of Houston, Houston, Texas 77204)

  • Teck-Hua Ho

    ()
    (Haas School of Business, University of California at Berkeley, Berkeley, California 94720)

Abstract

When designing price contracts, one of the major questions confronting managers is how many blocks there should be in the contract. We investigate this question in the setting of a manufacturer-retailer dyad facing a linear deterministic consumer demand. Theoretical marketing models predict that the manufacturer's profits rise dramatically when the number of blocks in the contract is increased from one to two because both channel efficiency and its share of channel profits increase. However, increasing the number of blocks to three yields no incremental profits. We test these predictions experimentally and find that increasing the number of blocks from one to two raises channel efficiency but not the manufacturer's share of profits. Surprisingly, having three blocks in the contract increases channel efficiency even further and also gives the manufacturer a slightly higher share of profits. We show that these results can be explained by a quantal response equilibrium model in which the manufacturer accounts for noisy best response due to nonpecuniary payoff components in the retailer's utility. We also show that the retailer is sensitive to the counterfactual profits it could have earned if it were charged a lower marginal price for earlier blocks in the multiple-block contract.

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File URL: http://dx.doi.org/10.1287/mksc.1070.0271
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Bibliographic Info

Article provided by INFORMS in its journal Marketing Science.

Volume (Year): 26 (2007)
Issue (Month): 3 (05-06)
Pages: 312-326

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Handle: RePEc:inm:ormksc:v:26:y:2007:i:3:p:312-326

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Related research

Keywords: quantity discounts; price contracts; quantal response equilibrium; experimental economics; behavioral economics;

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Cited by:
  1. Teck-Hua Ho & Xuanming Su, 2009. "Peer-Induced Fairness in Games," American Economic Review, American Economic Association, vol. 99(5), pages 2022-49, December.
  2. Wu, Diana Yan, 2013. "The impact of repeated interactions on supply chain contracts: A laboratory study," International Journal of Production Economics, Elsevier, vol. 142(1), pages 3-15.
  3. Avi Goldfarb & Teck-Hua Ho & Wilfred Amaldoss & Alexander Brown & Yan Chen & Tony Cui & Alberto Galasso & Tanjim Hossain & Ming Hsu & Noah Lim & Mo Xiao & Botao Yang, 2012. "Behavioral models of managerial decision-making," Marketing Letters, Springer, vol. 23(2), pages 405-421, June.
  4. Anne Coughlan & S. Choi & Wujin Chu & Charles Ingene & Sridhar Moorthy & V. Padmanabhan & Jagmohan Raju & David Soberman & Richard Staelin & Z. Zhang, 2010. "Marketing modeling reality and the realities of marketing modeling," Marketing Letters, Springer, vol. 21(3), pages 317-333, September.

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