This paper examines the issue of price and advertising coordination in bilateral monopolies from a dynamic perspective. Its main objectives are to design incentive mechanisms that the manufacturer can use in order to reduce double marginalization, and to investigate whether these mechanisms can be implemented by the manufacturer and accepted by the retailer. To answer these questions, we consider a differential game where a manufacturer controls its wholesale price and its national advertising effort. The carry-over effects of national advertising build up brand goodwill (i.e., equity or image), which represents the model's state variable. The retailer controls the product's retail price and the local advertising effort, which affect consumer demand, in conjunction with the brand goodwill. We compute strategies and outcomes under three scenarios: (i) a fully coordinated scenario where channel members act as if the channel was vertically integrated, (ii) a non coordinated scenario, considered as the status quo, where the channel is decentralized, and (iii)\ a scenario where incentive mechanisms are offered by the manufacturer. The main results indicate that two incentive mechanisms, namely, a wholesale-price reduction and an advertising allowance offered by the manufacturer to the retailer, mitigate the double-marginalization problem since they push both channel members to decrease their margins relative to the status-quo scenario. Furthermore, with these incentives, the manufacturer invests more in national advertising than under the status quo. Interestingly, this level is different (i.e., lower) than the fully coordinating level of national advertising. This means that with the incentives, the manufacturer can induce the retailer to fix its control variables at their fully coordinating levels without committing to implementing the fully coordinating level of national advertising. Demand and goodwill are higher with the incentives, and both channel members benefit from an increase in their individual profits (i.e., relative to the status quo).
Published June 2016 , 19 pages