The Agency Model and MFN Clauses

I provide a general analysis of vertical relations that are intermediated either with wholesale prices or with revenue-sharing contracts. Although revenuesharing does not eliminate double markups, it nonetheless tends to lower retail prices. Revenue-sharing is extremely attractive to the firm that is able to set the revenue shares, but often makes the other firm worse off. These results hold even when there is imperfect competition at both layers of the supply chain. I also show that retail price-parity restrictions raise industry prices. These results explain why many online retailers have adopted the “agency model” (in which they set revenue shares and suppliers set retail prices) and price-parity clauses. Finally, in an extension that considers private bargaining, I show that unobservable delegations can have equilibrium effects, and identify how pricing discretion can improve a firm’s bargaining position. It is common for vertical relations to be structured so that one firm sets the “terms of trade” governing exchange with another firm that then sets a retail price to end consumers. These terms of trade stipulate either a per-unit commission or instead a revenue-sharing term. In this article I present a general analysis of such vertical relations. I also investigate the effect of retail price-parity restrictions such as most-favored nation clauses. My analysis encompasses not only bilateral monopoly but also bilateral imperfect competition (in which there is market power at both stages of supply), and allows for flexibility in which firms in the supply chain set the terms of trade and which set retail prices. Thus, for example, not only am I able to compare how revenue-sharing differs from constant commissions given that the same firms set the terms of trade in either circumstance, but I am also able to assess the effects of a change in which firms set these terms. This flexibility allows me to evaluate an important shift that is taking place in retailing, especially in online markets. Traditionally, it has been most common for suppliers to set wholesale prices and retailers to set retail prices; this is called the “wholesale model of sales.” With growing prevalence, however, online retailers instead specify a share of revenue that their suppliers will receive, with suppliers then setting the retail price; this is called the “agency model of sales.” I thank Rabah Amir, Aaron Edlin, Justin Ho, Thomas Jeitschko, Jin Li, Sridhar Moorthy, Daniel O’Brien, Tony Curzon Price, Thomas Ross, Henry Schneider, and Michael Waldman. I especially thank Marco Ottaviani, Yossi Spiegel, Glen Weyl, and three anonymous referees for extensive comments. Johnson Graduate School of Management, Cornell University. Email: [email protected].