Vertical Contracts with Endogenous Product Selection: An Empirical Analysis of Vendor-Allowance Contracts

Abstract

Producers frequently provide retailers with financial incentives to secure distribution of their products. These payments often take the form of vendor allowances: lump-sum transfers to retailers that do not directly depend on quantity sold. First, I introduce an estimation strategy that uses observed product selections to inform us about lump-sum payments. I use retailers’ replacement threats, which may allow them to capture both vendor transfers and lower wholesale prices. Results imply that replacement threats influence equilibrium prices and total surplus in addition to the split in profits between upstream and downstream firms. A counterfactual restricts firms to only contract on wholesale prices. Results show that vendor allowances may have not only (negative) product distortion effects but also (potentially positive) pricing effects.