Resale Price Maintenance: Customer Service Without Free Riding

Abstract

Recent judicial legalizations of resale price maintenance (RPM) allow a manufacturer to establish limits to the prices that its retailers charge: a maximum price (a ceiling) or a minimum price (a floor). A manufacturer can also choose not to apply an RPM constraint. To determine how RPM affects service levels and the distribution of profit between channel members, we derive the optimal RPM strategy for a manufacturer that sells through competing retailers who provide their own optimal level of demand-enhancing customer service. Our analysis yields four key insights into a manufacturer's use of RPM in the absence of free riding.First, there are conditions for which a manufacturer benefits by applying either an RPM Ceiling or an RPM Floor, but there are also conditions that cause the manufacturer not to intervene in its retailers’ pricing decisions. Second, a manufacturer's use of RPM depends on how effectively its retailers provide service, and their service-effectiveness disparity. Third, intensity of inter-retailer competition affects the manufacturer's optimal application of RPM. Fourth, RPM Floors often enhance a large retailer's profit relative to the absence of RPM – but this does not hold for a small retailer. Our findings generate significant managerial implications, insights into the consequences of laws that allow manufacturers to limit their retailers’ pricing decisions. We also offer suggestions for future research.