Do Style-Goods Retailers’ Demands for Guaranteed Profit Margins Unfairly Exploit Vendors?

Abstract

Retailers, particularly those in the style-goods and fashion apparel industry, are increasingly demanding guaranteed profit margins (GPMs) from their vendors. Under a GPM stipulation, a vendor has to offer a rebate to maintain the retailer’s target margin on the item if the retailer is compelled to take a markdown from the initial price to sell out the ordered quantity for the season. Vendors dispute retailers’ claim that a GPM is a “win-win” mechanism for both parties. They rather view it as a coercive device. The authors examine this issue in a multistage game with demand uncertainty. Interestingly, the analysis shows that depending on the level of demand uncertainty, it may be optimal for the vendor to lower rather than raise his wholesale price upon being asked for a GPM. Further, the analysis shows that under conditions of low demand uncertainty the provision of a GPM by the vendor to the retailer can indeed yield higher profits for both parties than in the NO GPM case.