MANAGING A DISTRIBUTION CHANNEL UNDER ASYMMETRIC INFORMATION WITH PERFORMANCE REQUIREMENTS

In this paper we study how performance requirements may improve the wo rking of a distribution channel when the retailer is better informed a bout demand conditions than the manufacturer. Performance requirements means that the manufacturer and retailer agree to (1) have the manufa cturer set requirements on retail price or service or both, and (2) jo intly invest in the information systems required to monitor the retail er's compliance with the requirements. We show that performance requir ements on price and service will improve channel performance. But if r equirements cannot be set on both performance dimensions, the choice a mong the remaining options is not straightforward Price requirements m ay be worse than no requirements, and service requirements no better. The central problem with setting requirements on only one dimension is that the retailer then behaves suboptimally on the other. Between the two partial options, service requirements are better than price requi rements in aligning the interests of the manufacturer and the retailer , whereas price requirements are better at inducing the retailer to re veal his demand.