Price-Dependent Profit Sharing as a Channel Coordination Device

We show how an upstream …rm by using a price-dependent pro…tsharing rule can prevent destructive competition between downstream …rms that produce relatively close substitutes. With this rule the upstream …rm induces the retailers to behave as if demand has become less price elastic. As a result, competing downstream …rms will maximize aggregate total channel pro…t. When downstream …rms are better informed about demand conditions than the upstream …rm, the same outcome cannot be achieved by vertical restraints such as resale price maintenance (RPM). Price-dependent pro…t-sharing may also ensure that the downstream …rms undertake e¢ cient market expanding investments. The model is consistent with observations from the market for content commodities distributed by mobile networks.