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Revenue Sharing, Demand Uncertainty, and Vertical Control of Competing Firms

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Author Info

  • James D. Dana

    (Northwestern University)

  • Kathryn Spier

    (Northwestern University)

Abstract

This paper argues that revenue sharing is a valuable instrument in vertically separated industries when there is intrabrand competition among the downstream firms, demand is stochastic or variable, and downstream inventory is chosen before demand is realized. In these environments, the upstream firm would like to simultaneously soften downstream competition and encourage efficient inventory holding. Traditional two-part tariffs cannot achieve both objectives in the presence of downstream competition. Raising the price of the inputs softens price competition but distorts the downstream firms' inventory decisions. We argue that revenue sharing, combined with a low input price, aligns the incentives in the vertical chain. The use of revenue sharing in video rental retailing is discussed. Blockbuster in particular has used revenue sharing in conjunction with heavy marketing of availability to grow significantly in the video rental retail industry. Many other outlets use revenue sharing as well. Some antitrust concerns have been raised by smaller firms suggesting that revenue sharing might be an anticompetitive vertical restraint. Although our model does not address retailer market power, we show that revenue sharing contracts can be used by upstream firms increase inventory holding and consumer welfare.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1511.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1511

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  1. Mallela, Parthasaradhi & Nahata, Babu, 1980. "Theory of Vertical Control with Variable Proportions," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 1009-25, October.
  2. Prescott, Edward C, 1975. "Efficiency of the Natural Rate," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1229-36, December.
  3. Marvel, Howard P & Peck, James, 1995. "Demand Uncertainty and Returns Policies," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(3), pages 691-714, August.
  4. Barry Alan Pasternack, 1985. "Optimal Pricing and Return Policies for Perishable Commodities," Marketing Science, INFORMS, vol. 4(2), pages 166-176.
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  6. repec:att:wimass:9507 is not listed on IDEAS
  7. Deneckere, Raymond & Marvel, Howard P & Peck, James, 1997. "Demand Uncertainty and Price Maintenance: Markdowns as Destructive Competition," American Economic Review, American Economic Association, vol. 87(4), pages 619-41, September.
  8. Warren-Boulton, Frederick R, 1977. "Vertical Control by Labor Unions," American Economic Review, American Economic Association, vol. 67(3), pages 309-22, June.
  9. D. W. Carlton, 1976. "Market Behavior With Demand Uncertainty and Price Inflexibility," Working papers 179, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Dana, James D, Jr & Spier, Kathryn E, 1993. "Expertise and Contingent Fees: The Role of Asymmetric Information in Attorney Compensation," Journal of Law, Economics and Organization, Oxford University Press, vol. 9(2), pages 349-67, October.
  11. Daniel P. O'Brien & Greg Shaffer, 1992. "Vertical Control with Bilateral Contracts," RAND Journal of Economics, The RAND Corporation, vol. 23(3), pages 299-308, Autumn.
  12. Sugato Bhattacharyya & Francine Lafontaine, 1995. "Double-Sided Moral Hazard and the Nature of Share Contracts," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 761-781, Winter.
  13. Kandel, Eugene, 1996. "The Right to Return," Journal of Law and Economics, University of Chicago Press, vol. 39(1), pages 329-56, April.
  14. Alexander, Cindy R & Reiffen, David, 1995. "Vertical Contracts as Strategic Commitments: How Are They Enforced?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(4), pages 623-49, Winter.
  15. Beggs, A. W., 1992. "The licensing of patents under asymmetric information," International Journal of Industrial Organization, Elsevier, vol. 10(2), pages 171-191, June.
  16. Hart, O. & Tirole, J., 1990. "Vertical Integration And Market Foreclosure," Working papers 548, Massachusetts Institute of Technology (MIT), Department of Economics.
  17. V. Padmanabhan & I. P. L. Png, 1997. "Manufacturer's Return Policies and Retail Competition," Marketing Science, INFORMS, vol. 16(1), pages 81-94.
  18. Warren-Boulton, Frederick R, 1974. "Vertical Control with Variable Proportions," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 783-802, July/Aug..
  19. Butz, David A, 1997. "Vertical Price Controls with Uncertain Demand," Journal of Law and Economics, University of Chicago Press, vol. 40(2), pages 433-59, October.
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Cited by:
  1. Ioannis Ioannou & Julie Holland Mortimer & Richard Mortimer, 2011. "The Effects Of Capacity On Sales Under Alternative Vertical Contracts," Journal of Industrial Economics, Wiley Blackwell, vol. 59(1), pages 117-154, 03.
  2. Hal R. Varian, 2001. "High-technology industries and market structure," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 65-101.

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