Paying for Shelf Space: An Investigation of Merchandising Allowances in the Grocery Industry

Merchandising allowances are fees paid by manufacturers to retailers in order to encourage the allocation of in-store promotional activities to the manufacturers' brand. I use a three-stage game framework to formulate a vertical structural model, which endogenizes manufacturer, retailer, and consumer decisions in the presence of merchandising allowances. The model allows for non-linear vertical pricing contracts using merchandising allowances paid to retailers. This differs from previous work which has focused on franchise fees paid to manufacturers. The model is estimated using store-level weekly data from the ketchup industry. In addition to estimates of consumer taste parameters, the model also yields predictions of wholesale prices and the size (dollar value) of the merchandising allowances. Counterfactual simulations reveal that merchandising allowances lead to an increase in retail profits, a decline in manufacturer profits, a decline in consumer surplus, and reduction in total welfare.