IDEAS home Printed from https://ideas.repec.org/a/inm/ormksc/v15y1996i2p132-151.html
   My bibliography  Save this article

The Inverse Relationship Between Manufacturer and Retailer Margins: A Theory

Author

Listed:
  • Rajiv Lal

    (Stanford University)

  • Chakravarthi Narasimhan

    (Washington University)

Abstract

Our objective in this paper is to explain the relationship between a manufacturer's brand advertising and its impact on wholesale and retail margins in consumer goods markets. We construct a model of re-tailers and manufacturers, and using tools from game theory explain why under some conditions a manufacturer's advertising can squeeze, i.e., lower, the retail margin while simultaneously increasing the wholesale margin. Our paper should be of interest to applied analytical and empirical researchers in marketing as well as managers interested in understanding the strategic impact of brand advertising on margins. The consumer goods retail market is characterized by intense rivalry among retailers competing for a share of the consumer dollar. Retailers carry many products, and on any given purchase occasion a typical consumer buys a subset of the vast number of items a retailer has on its shelf. In general consumers are ignorant about the prices of all the products they want to buy and consequently select a retailer to shop at based on the advertised prices of a subset of the products they intend to buy. Given this, retailers tend to compete more aggressively based on the prices of a selected set of items by advertising these prices to consumers. The items that the retailers select to compete on are those that most consumers desire and value highly. Since the profit from any customer is the sum of profits from advertised and unadvertised items, the intensity of retail competition, as evident from the prices of these items, increases with the amount the consumer will expend on the unadvertised items once at the store. This aggressiveness therefore translates into lower retail margins on these selected items since the retailers expect that consumers, once inside a store, will buy non-advertised products as well on which the retailers make money. Thus manufacturers who are more adept at using “pull” strategies to enhance the popularity of their product, obtain d significant competitive advantage vis à vis others. The positioning of the product and the image conveyed through advertising act as drivers in creating this advantage which results in higher wholesale prices that these manufacturers can charge the retailers. There are several key insights from our analysis. Our model explains why retail and wholesale margins can move in opposite directions and also suggests when—in those retail markets where consumers shop for a basket of goods. Our analysis also reveals that retailers make higher margins on unadvertised products and less on advertised products. Furthermore it shows the power of a popular brand where its popularity can be enhanced through brand advertising. From a managerial standpoint we also show that the effectiveness of advertising should not be narrowly interpreted in terms of increase in share or awareness but should include the ability to charge a higher wholesale price. Finally our analysis sheds light on extant, and provides guidance to future, empirical work in this area.

Suggested Citation

  • Rajiv Lal & Chakravarthi Narasimhan, 1996. "The Inverse Relationship Between Manufacturer and Retailer Margins: A Theory," Marketing Science, INFORMS, vol. 15(2), pages 132-151.
  • Handle: RePEc:inm:ormksc:v:15:y:1996:i:2:p:132-151
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1287/mksc.15.2.132
    Download Restriction: no

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Kostas Axarloglou, 2007. "Thick markets, market competition and pricing dynamics: evidence from retailers," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(7), pages 669-677.
    2. Greg Shaffer & Florian Zettelmeyer, 2009. "Comparative Advertising and In-Store Displays," Marketing Science, INFORMS, vol. 28(6), pages 1144-1156, 11-12.
    3. repec:gam:jsusta:v:10:y:2018:i:5:p:1658-:d:148154 is not listed on IDEAS
    4. Stefan Buehler & Dennis L. Gärtner, 2013. "Making Sense of Nonbinding Retail-Price Recommendations," American Economic Review, American Economic Association, vol. 103(1), pages 335-359, February.
    5. Robert B. Barsky & Mark Bergen & Shantanu Dutta & Daniel Levy, 2003. "What Can the Price Gap between Branded and Private-Label Products Tell Us about Markups?," NBER Chapters,in: Scanner Data and Price Indexes, pages 165-228 National Bureau of Economic Research, Inc.
    6. Karray Salma & Martín-Herrán Guiomar, 2008. "Investigating the Relationship Between Advertising and Pricing in a Channel with Private Label Offering: A Theoretic Model," Review of Marketing Science, De Gruyter, vol. 6(1), pages 1-39, August.
    7. Noriaki Matsushima & Akira Miyaoka, 2013. "Who benefits from resale-below-cost laws?," ISER Discussion Paper 0875, Institute of Social and Economic Research, Osaka University.
    8. Draganska, Michaela & Klapper, Daniel, 2006. "Retail Environment and Manufacturer Competitive Intensity," Research Papers 1953, Stanford University, Graduate School of Business.
    9. Vincent Nijs & Kanishka Misra & Eric T. Anderson & Karsten Hansen & Lakshman Krishnamurthi, 2010. "Channel Pass-Through of Trade Promotions," Marketing Science, INFORMS, vol. 29(2), pages 250-267, 03-04.
    10. Shuba Srinivasan & Koen Pauwels & Dominique M. Hanssens & Marnik G. Dekimpe, 2004. "Do Promotions Benefit Manufacturers, Retailers, or Both?," Management Science, INFORMS, vol. 50(5), pages 617-629, May.
    11. Sang Yong Kim & Richard Staelin, 1999. "Manufacturer Allowances and Retailer Pass-Through Rates in a Competitive Environment," Marketing Science, INFORMS, vol. 18(1), pages 59-76.
    12. repec:eee:jouret:v:91:y:2015:i:4:p:569-585 is not listed on IDEAS
    13. Hovhannisyan, Vardges & Stiegert, Kyle & Bozic, Marin, 2014. "On the Endogeneity of Retail Markups in an Equilibrium Analysis: A Control-Function Approach," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 0(Number 2), pages 1-13.
    14. 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.
    15. 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.
    16. repec:eee:ijrema:v:32:y:2015:i:2:p:124-154 is not listed on IDEAS
    17. repec:eee:ijrema:v:34:y:2017:i:3:p:694-716 is not listed on IDEAS
    18. Tansev Geylani & Anthony J. Dukes & Kannan Srinivasan, 2007. "Strategic Manufacturer Response to a Dominant Retailer," Marketing Science, INFORMS, vol. 26(2), pages 164-178, 03-04.
    19. Kevin Lane Keller & Donald R. Lehmann, 2006. "Brands and Branding: Research Findings and Future Priorities," Marketing Science, INFORMS, vol. 25(6), pages 740-759, 11-12.
    20. repec:eee:jouret:v:93:y:2017:i:1:p:120-135 is not listed on IDEAS

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ormksc:v:15:y:1996:i:2:p:132-151. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mirko Janc). General contact details of provider: http://edirc.repec.org/data/inforea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.