Why do suppliers choose wholesale price contracts? End-of-season payments disincentivize retailer marketing effort

Abstract

Although theoretical work has shown that end-of-season payment contracts, which allow suppliers and retailers to share the cost of unsold inventory, increase total profit, most suppliers and retailers today still use simple wholesale price contracts. In a series of experimental studies, we show that supplier preferences for wholesale price contracts can be explained by their concern that end-of-season payments contracts will disincentivize retailer marketing effort. Moreover, suppliers’ pessimistic predictions regarding reduced retailer effort are confirmed by retailers’ reduced investment in marketing effort in our experiments. Our results suggest that for suppliers and retailers to benefit from end-of-season payments contracts, retailers should publicize their demand-enhancing marketing practices.