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Formula Pricing and Profit Sharing in Inter‐Firm Contracts

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  • Lowell R. Jacobsen
  • Roger D. Blair
  • Francine Lafontaine

Abstract

Ronald Coase viewed transaction cost minimization as a central goal of contracting and organizational decisions. We discuss how a solution to the traditional successive monopoly problem that has not been discussed in the literature can economize on such costs. Specifically, we show that when we allow for profit sharing between upstream and downstream firms, a simple formula pricing contract can be used to generate the vertically integrated level of profits. This simple contract, empirically, would take the form of the standard linear wholesale price contracts that are ubiquitous in vertical contexts, even those where we might expect successive monopoly to be an issue. We discuss the advantages of the proposed contract from a transaction cost perspective. We also discuss some of its limitations, in particular the likelihood of misrepresentation of costs, and ways in which such misrepresentation might be addressed in the contract. Copyright © 2014 John Wiley & Sons, Ltd.

Suggested Citation

  • Lowell R. Jacobsen & Roger D. Blair & Francine Lafontaine, 2015. "Formula Pricing and Profit Sharing in Inter‐Firm Contracts," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 36(1), pages 33-43, January.
    • Handle: RePEc:wly:mgtdec:v:36:y:2015:i:1:p:33-43
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    Cited by:

    1. Janssen, Maarten C.W., 2020. "Vertical contracts in search markets," International Journal of Industrial Organization, Elsevier, vol. 70(C).
    2. Janssen, Maarten & Reshidi, Edona, 2018. "Retail Discrimination in Search Markets," CEPR Discussion Papers 12945, C.E.P.R. Discussion Papers.
    3. Yan, Ruiliang & Pei, Zhi, 2019. "Return policies and O2O coordination in the e-tailing age," Journal of Retailing and Consumer Services, Elsevier, vol. 50(C), pages 314-321.
    4. Pei, Zhi & Wooldridge, Barbara Ross & Swimberghe, Krist R., 2021. "Manufacturer rebate and channel coordination in O2O retailing," Journal of Retailing and Consumer Services, Elsevier, vol. 58(C).
    5. Janssen, Maarten & Reshidi, Edona, 2022. "Regulating recommended retail prices," International Journal of Industrial Organization, Elsevier, vol. 85(C).
    6. Tirza J. Angerhofer & Roger D. Blair, 2021. "Successive Monopoly, Bilateral Monopoly and Vertical Mergers," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 59(2), pages 343-361, September.
    7. Yan, Ruiliang & Pei, Zhi & Ghose, Sanjoy, 2019. "Reward points, profit sharing, and valuable coordination mechanism in the O2O era," International Journal of Production Economics, Elsevier, vol. 215(C), pages 34-47.

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