Investment Incentives in Multi-Product Distribution Channels

Abstract

Distribution channels in which a common retailer undertakes long-term investments and coordinates the sale of competing products are prevalent in many industries. We study how the allocation of bargaining power among the retailer and the suppliers affects investment incentives, market shares, and profits. We identify conditions for efficient investment in terms of the parties' relative bargaining powers, market shares, and the sensitivity of consumer demand to investment. Compared to outcomes in two-party distribution channels, where the absolute bargaining power of the retailer relative to the supplier determines the degree of underinvestment, our analysis reveals the following differences: (i) The relative bargaining power of suppliers that do not negotiate directly with each other is a key determinant of investment, productive efficiency, and channel efficiency. (ii) Investments can be efficient even when the investing retailer has less than full bargaining power, or inefficient when the retailer does have full bargaining power. (iii) Inefficiencies can occur as both under- or overinvestment, with a corresponding misallocation of market shares. (iv) Channel profitability is an inverted-U shaped function of the retailer's bargaining power. (v) Higher retailer bargaining power relative to one supplier reduces the profit of the other supplier. Our insights are robust when the retailer or the suppliers can undertake long-term product-specific investments or when the multi-product channel consists of a backward-integrated retailer and an independent supplier.