Managing gray markets through tolerance of violations: a transaction cost perspective

Mark Bergen, Jan B. Heide and Shantanu Dutta
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Mark Bergen: Carlson School of Management, University of Minnesota, USA, Postal: Carlson School of Management, University of Minnesota, USA
Jan B. Heide: School of Business, University of Wisconsin-Madison, USA, Postal: School of Business, University of Wisconsin-Madison, USA
Shantanu Dutta: Marshall School of Business, University of Southern California, USA, Postal: Marshall School of Business, University of Southern California, USA

Managerial and Decision Economics, 1998, vol. 19, issue 3, 157-165

Abstract: Exclusive territory distribution arrangements are commonly observed in many markets. Once deployed, such arrangements are often subject to gray market activity, in the form of unauthorized sales which violate assigned restrictions. Interestingly, however, firms frequently choose to tolerate violations, rather than pursuing complete enforcement (i.e., by terminating violators) or abandoning exclusivity entirely. We draw from the literature on transaction cost economics to propose that tolerance of gray market activity is a function of a firm's ability to detect violations, and of the existence of credible threats and commitments. We also draw on the traditional literature on exclusive territories to suggest that minimizing distributor free-riding on services, which influences the decision to use exclusive territories in the first place, continues to be a concern after deployment. We collect micro-level data and test our predictions through a survey of managers who were responsible for the distribution decisions in their respective companies. Our results suggest that tolerance of violations is influenced both by transaction cost and free-riding considerations. © 1998 John Wiley & Sons, Ltd.

Date: 1998
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Persistent link: https://EconPapers.repec.org/RePEc:wly:mgtdec:v:19:y:1998:i:3:p:157-165

DOI: 10.1002/(SICI)1099-1468(199805)19:3<157::AID-MDE880>3.0.CO;2-E

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