with V. Padmanabhan
Abstract
Slotting allowances-lump sum transfers from manufacturers to
retailers for carrying new products-have become an important part of
promotional agreements over the past decade. Hardly known before the mid-1980s,
they now represent a significant cost to launching a new entry in a wide range
of product categories. Despite being commonplace, slotting allowances have
remained extremely controversial both with manufacturers and retailers. The
controversy, in part, follows from a poor understanding of the role that
slotting allowances actually play in new product introductions. We attempt to
clarify the purpose slotting allowances serve by relating the payment of a
slotting allowance to the retailer's cost structure and informational
asymmetries within a channel. We consider a manufacturer introducing a new
product into a retail channel. The retailer is independent of the manufacturer
and only accepts the product if he expects to recover a positive fixed cost at
the terms of trade offered by the manufacturer. Following acceptance, the
retailer exerts merchandising effort and sets the retail price. We show that if
the manufacturer and the retailer are equally informed of the product's demand,
the terms of trade never include a slotting allowance. High retail costs are
compensated through a lower wholesale price. Similarly, if the manufacturer is
better informed of the product's demand, she prefers to convey that information
through the wholesale price alone. That is, a high wholesale price, not a
slotting allowance, is the manufacturer's preferred signaling instrument.
Signaling with the wholesale price alone fails, however, when the retailer has
high fixed costs. To convey information and assure retailer participation, the
terms of trade must include a positive slotting allowance. A slotting allowance
thus serves two purposes in launching a product: passing information down to
the retailer and shifting costs up to the manufacturer. We show that the
manufacturer prefers paying a slotting allowance to undertaking purely wasteful
advertising. A principal virtue of a slotting allowance, then, is keeping money
within the channel. Our work is novel along two important dimensions. First,
others (e.g.,
Key words: Slotting allowances; Channel Management; Asymmetric Information; New Product Introductions; Signaling