The Effects of a Two-stage Ordering Process and Quantity Discounts on Vertical Channel Relationships: Theory and Evidence

Desmond (Ho-Fu) Lo (University of Michigan)
Mrinal Ghosh (University of Arizona)
Stephen Salant (University of Michigan)

Abstract: Manufacturers often devise contractual mechanisms that enable downstream dealers to earn economic profit. One such mechanism is the two-stage ordering process with quantity discounts used by MNCs in their international distribution and other contexts. The authors theoretically and empirically demonstrate how an upstream profit-maximizing manufacturer can use the mechanism to ensure that its downstream dealers earn economic profits. They first construct a theory model that shows how it enables the manufacturer to control indirectly the intensity of downstream competition between its dealers. The authors then match the results of their model to a novel longitudinal data obtained from “Computec,” a leading Chinese manufacturer of a key computer accessory, and use the data to estimate the unobserved final retail prices, the price-cost markups, and the profits earned by their dealers over a one-year period. The authors show empirically that the ordering arrangement indeed is economically profitable for the dealers. The authors discuss the implications for research and practice in channel design and management.


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