Vertical Contracts with Endogenous Product Selection: An Empirical Analysis of Vendor-Allowance Contracts

Abstract

Producers frequently provide retailers with financial incentives to secure distribution of their products. These payments often take the form of vendor allowances: lump-sum transfers to retailers that do not directly depend on quantity sold. I study equilibrium effects of vendor allowances when retailers' product selections are endogenous and vertical contracts are unobserved. I introduce an estimation strategy that uses rich information from observed product selections to inform us about lump-sum payments. Vendor allowances are estimated as the payments needed to rationalize observed assortments. For the empirical analysis, estimates imply that these transfers are important for retailers' profitability, corresponding to about 20% of retailers' variable profits. A counterfactual that restricts firms to only contract on wholesale prices predicts that lump-sum payments incentivize retailers to adjust their product selections. In the absence of vendor payments, total surplus increases because previously excluded low-cost products enter the market.