A bane or a boon? Profit‐margin‐guarantee contract in a channel with downstream competition

Hong Zheng, Lin Tian and Guo Li

Production and Operations Management, 2023, vol. 32, issue 7, 2087-2100

Abstract: In recent decades, manufacturers have relied on giant retailers or e‐tailers to distribute their products. Given this evolution, some retailers have started demanding a profit‐margin‐guarantee contract (PMG contract), under which the manufacturer must ensure that the retailer's profit margin does not fall below a certain level (PMG rate). Conventional wisdom suggests that a PMG contract creates a life‐or‐death struggle for the manufacturer and that a retailer with a PMG contract can gain a competitive edge over his competitors. This study investigates the strategic impact of the PMG contract in a competitive environment. We consider a distribution channel consisting of one manufacturer and two competing retailers. In this channel, the manufacturer has signed a PMG contract with one retailer (signed retailer) but not with the other (unsigned retailer). Our analyses show that in response to the PMG contract, the manufacturer can adopt a “cost‐independent” pricing strategy (i.e., setting the wholesale price independent of the production cost) to strategically trigger or void the PMG contract. For this reason, interestingly, the manufacturer is not always hurt by, nor does the signed retailer always benefit from, the PMG contract. Depending on the production cost and the downstream competition intensity, the PMG contract may yield a win–win, win–lose, lose–win, or lose–lose outcome for the manufacturer and the signed retailer. Moreover, the unsigned retailer may be able to free ride on the PMG contract, making her even better off under this unfavorable competitive situation. Nevertheless, the PMG contract cannot yield a win–win–win outcome for all firms, whereas a lose–lose–lose outcome may arise under certain conditions. Our results have useful managerial and regulatory implications.

Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://doi.org/10.1111/poms.13958

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:popmgt:v:32:y:2023:i:7:p:2087-2100

Ordering information: This journal article can be ordered from
http://onlinelibrary ... 1111/(ISSN)1937-5956

Access Statistics for this article

Production and Operations Management is currently edited by Kalyan Singhal

More articles in Production and Operations Management from Production and Operations Management Society
Bibliographic data for series maintained by Wiley Content Delivery ().