Vertical Contracts and Endogenous Product Selections: An Empirical Analysis of Vendor Allowance Contracts∗

Strategic retailers choose assortments taking consumer preferences, downstream competition, and vertical contracts into account. Thus, vertical contracts cannot be understood in isolation from retailers’ endogenous product selections. Producers frequently provide retailers with financial incentives to gain 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. I develop a framework to quantify lump-sum transfers using only data on retail prices, sales, and assortments. Model estimates imply that vendor allowances correspond to 4.21% of retailers’ revenues. To understand how vendor allowances affect market outcomes, a counterfactual analysis restricts contracts to include only wholesale prices. Simulations predict a decrease in retailers’ profits even though total vertical surplus increases. Moreover, the change in the vertical contract affects both equilibrium wholesale prices and product availability. ∗I thank Julie Holland Mortimer and Michael Grubb for their guidance, advice, and continued support. I also thank Alon Eizenberg, Paul Grieco, Wills Hickman, Arthur Lewbel, Peter Rossi, and Mark Rysman for valued comments and suggestions. I am also grateful for feedback from seminar participants at Boston College, University of Rochester, Stanford GSB, Tilburg University, UCLA Anderson, University of Michigan, and Yale SOM. All estimates and analyses in this paper based on SymphonyIRI Group, Inc. data are by the author and not by SymphonyIRI Group, Inc. All remaining mistakes are my own. This paper was previously circulated under the title “How do vertical contracts affect product availability? An empirical study of the grocery industry.” †UCLA Anderson School of Management; email: [email protected]