A manufacturer's incentives to undertake non-contractible investments depend on the profit margin on her sales to the retailer, and slotting allowances can facilitate such incentives by increasing unit wholesale prices. At first glance, it is tempting to conclude that slotting allowances should be particularly prevalent for product categories where the manufacturer's scope for undertaking non-contractible sales effort is relatively large. At odds with this, The Federal Trade Commission, among others, reports that slotting allowances are more commonly used for product categories where the scope for non-contractible effort by the manufacturer is presumably relatively small. To scrutinize this puzzle we set up a simple model with one manufacturer and one retailer, where the manufacturer undertakes noncontractible demand-enhancing investments. The predictions from the model are consistent with the market observations. In particular, we show that even a retailer with complete bargaining power may actually find it optimal to pay the manufacturer a franchising fee if demand is highly sensitive to the manufacturer's non-contractible sales effort. For product categories where the scope for non-contractible effort is relatively small, on the other hand, we are more likely to see slotting allowances.
Slotting allowances non-contractible sales effort bargaining power