A Theory of Conventional Channel with Kickbacks

Abstract

The frequently studied conventional distribution channel has largely overlooked the role of the retail buyer who is employed by the retailer to procure products from the manufacturer. In many economies and industries, the presence of the buyer opens the door for the manufacturer to distort buying decisions by offering the buyer a kickback. In this paper, we introduce the retail buyer in the conventional channel and explore her role when kickbacks are feasible. We examine a context where the buyer may be responsible for ordering the right quantity from the manufacturer to match uncertain demand. A knowledgeable buyer can always help improve the channel efficiency when the channel is clean of any kickbacks. However, when kickbacks are possible, we show that, ironically, the manufacturer may not be the one who benefits. Instead, the retailer or buyer may be made better off. While kickbacks can incentivize the buyer to act against the retailer's interest, the retailer can strategically take advantage of the kickback so as to lower its cost of employing the buyer, effectively shifting the cost to the manufacturer. In fact, the retailer may even tacitly encourage kickbacks and not do all it can to eliminate kickbacks from taking place even if doing so adds no additional cost. Surprisingly, the presence of kickbacks can improve channel efficiency and be a win-win for the retailer and the manufacturer.

Keywords: Channel Conflict, Delegation, Distribution Channel, Kickback, Retail Buyers, Game Theory

JEL Classification: D82, C72, L14, M31