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

Abstract

Producers frequently provide retailers with financial incentives to secure product distribution. These payments often take the form of vendor allowances: lump-sum transfers to retailers that do not directly depend on quantity sold. I introduce an estimation strategy that uses observed product selections to inform unobserved allowances. I use retailers’ replacement threats, which may allow them to capture both vendor transfers and lower wholesale prices. A counterfactual restricts firms to contract on only wholesale prices. Results show that vendor allowances may have not only (negative) product distortion effects but also (potentially positive) pricing effects.