Manufacturer Allowances and Retailer Pass-Through Rates in a Competitive Environment
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.
Volume (Year): 18 (1999)
Issue (Month): 1 ()
|Contact details of provider:|| Postal: 7240 Parkway Drive, Suite 300, Hanover, MD 21076 USA|
Web page: http://www.informs.org/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Peter M. Guadagni & John D. C. Little, 1983. "A Logit Model of Brand Choice Calibrated on Scanner Data," Marketing Science, INFORMS, vol. 2(3), pages 203-238.
- J. Jeffrey Inman & Leigh McAlister, 1993. "A Retailer Promotion Policy Model Considering Promotion Signal Sensitivity," Marketing Science, INFORMS, vol. 12(4), pages 339-356.
- Lal, Rajiv & Matutes, Carmen, 1994. "Retail Pricing and Advertising Strategies," The Journal of Business, University of Chicago Press, vol. 67(3), pages 345-370, July.
- Anil Kaul & Dick R. Wittink, 1995. "Empirical Generalizations About the Impact of Advertising on Price Sensitivity and Price," Marketing Science, INFORMS, vol. 14(3_supplem), pages 151-160.
- Eitan Gerstner & James D. Hess, 1995. "Pull Promotions and Channel Coordination," Marketing Science, INFORMS, vol. 14(1), pages 43-60.
- G. Dekimpe, Marnik & Hanssens, Dominique M. & Silva-Risso, Jorge M., 1998. "Long-run effects of price promotions in scanner markets," Journal of Econometrics, Elsevier, vol. 89(1-2), pages 269-291, November.
- Deepak Agrawal, 1996. "Effect of Brand Loyalty on Advertising and Trade Promotions: A Game Theoretic Analysis with Empirical Evidence," Marketing Science, INFORMS, vol. 15(1), pages 86-108.
- Timothy W. McGuire & Richard Staelin, 1983. "An Industry Equilibrium Analysis of Downstream Vertical Integration," Marketing Science, INFORMS, vol. 2(2), pages 161-191.
- Steven M. Shugan, 1985. "Implicit Understandings in Channels of Distribution," Management Science, INFORMS, vol. 31(4), pages 435-460, April.
- Abel P. Jeuland & Steven M. Shugan, 1988. "Note—Channel of Distribution Profits When Channel Members Form Conjectures," Marketing Science, INFORMS, vol. 7(2), pages 202-210.
- S. Chan Choi, 1991. "Price Competition in a Channel Structure with a Common Retailer," Marketing Science, INFORMS, vol. 10(4), pages 271-296.
- David R. Bell & Jeongwen Chiang & V. Padmanabhan, 1999. "The Decomposition of Promotional Response: An Empirical Generalization," Marketing Science, INFORMS, vol. 18(4), pages 504-526.
- Chernev, Alex, 1997. " The Effect of Common Features on Brand Choice: Moderating Role of Attribute Importance," Journal of Consumer Research, Oxford University Press, vol. 23(4), pages 304-311, March.
- Inman, J Jeffrey & McAlister, Leigh & Hoyer, Wayne D, 1990. " Promotion Signal: Proxy for a Price Cut?," Journal of Consumer Research, Oxford University Press, vol. 17(1), pages 74-81, June.
- Rajiv Lal & Ram Rao, 1997. "Supermarket Competition: The Case of Every Day Low Pricing," Marketing Science, INFORMS, vol. 16(1), pages 60-80.
- Rajiv Lal & Chakravarthi Narasimhan, 1996. "The Inverse Relationship Between Manufacturer and Retailer Margins: A Theory," Marketing Science, INFORMS, vol. 15(2), pages 132-151.
- Paul R. Messinger & Chakravarthi Narasimhan, 1995. "Has Power Shifted in the Grocery Channel?," Marketing Science, INFORMS, vol. 14(2), pages 189-223.
When requesting a correction, please mention this item's handle: RePEc:inm:ormksc:v:18:y:1999:i:1:p:59-76. 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)
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.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with 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 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.