THE ECONOMICS OF SLOTTING CONTRACTS
Joshua D. Wright
George Mason University
Silicon Flatirons
Law and New Institutional Economics Workshop
June 4, 2009
1
• This paper is co-authored with Benjamin Klein
and appears at 50 J.L.E. 421 (2007)
• Empirical follow up piece for those interested:
Slotting Contracts and Consumer Welfare, 74
Antitrust Law Journal 439 (2007).
2
Slotting arrangements: per unit time payments
made by manufacturers to retailers for shelf
space.
• usually bind the grocer to provide shelf placement for a six month to
•
•
•
•
one year period
can cover both new and established products
arose in grocery retailing around 1984
over the past 20 years, have become more pervasive, increasing in
size and covering a larger number of grocery products
have attracted a considerable amount of antitrust scrutiny including
numerous Congressional and FTC hearings, litigation, and proposed
legislation
3
Anticompetitive theories grounded in retail
bargaining power and/or manufacturer
exclusion of rivals do not explain the growth
and prevalence of slotting contracts:
• Frequently used by manufacturers and with small market shares
• Most involve only short-term shelf space commitments
• Significant economies of scale in manufacturing are absent for
many grocery products where we observe slotting contracts
• Anticompetitive theories do not explain the growth of
supermarket slotting contracts in the 1980s
4
Food Retailers' Profitability
(1980 - 2003)
8
7
6
Percent
5
4
3
2
1
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
After-tax Profits as a Percentage of Sales
After-tax Profits as a Percentage of Assets
Sources: Food Marketing Institute Annual Financial Review (profits as a percentage of sales); U.S. Department of Commerce, Food Cost Review
(profits as a percentage of assets).
5
Two key economic questions that must be
answered with respect to slotting fees are:
1)
Why must manufacturers explicitly contract with retailers for the
provision of shelf space?
2)
Why does the shelf space contract often involve a per unit time
payment to retailers rather than a wholesale price reduction?
6
Slotting contracts solve incentive incompatibility
involving retailer undersupply of promotion
when there are little or no inter-retailer
competitive effects from the supply of
promotional shelf space
7
A Promotional Services Theory of Slotting Contracts
Retailers supply less than the joint profit-maximizing level
of promotion because they do not consider the
manufacturer profit margin on incremental sales
For many products
• the retailer’s incremental profit
 (PR – MCR),
• is a small fraction of the manufacturer’s incremental profit

(PW – MCM)
8
For Price Competition:
inter-retailer competitive effects offset the
relatively small retail margin to approximately
produce the optimum amount of retail price
competition
(1)
dQ M
dQR
(PR – MCR) =
(PW – MCM)
dPW
dPR
9
dQR
is much greater thandQ M
dPR
dPW
because there are
inter-retailer competitive effects
in addition to
inter-brand competitive effects
10
However, because promotional shelf space
creates “impulse sales”, there are small interretailer demand effects
(2)
dQR
dS
dQ M
≈
dS
11
Therefore
dQR
dQ M
(3)
(PR – MCR) <
dS
dS
(PW – MCM)
12
The distortion is not present on all forms of nonprice competition.
If consumers value the non-price service
and will switch retailers in response to its
supply, e.g., free parking, the joint profitmaximizing quantity will be supplied.
dQR
dS
dQ M
(PR – MCR) =
(PW – MCM)
dS
13
In these fairly general circumstances, the manufacturer
will want the retailer to provide more promotional shelf
space for its products than the retailer would otherwise
provide and a separate contract for shelf space will be
necessary.
The greater the manufacturer margin compared to
retailer margin, the greater is this distortion.
14
Value Added as a Percentage of Sales for Food and Beverage
Manufacturers
(1965 - 2003)
50
45
(%)
40
35
30
25
2000
1995
1990
1985
1980
1975
1970
1965
20
Sources: U.S. Census Bureau: 1977, 1992 Census of Manufactures; 2002 Economic Census; (1993-1996 and 2002-2003 from Annual Survey of
Manufactures.) The 1965-1996 series is calculated using SIC 20 (Food and kindred products including beverages); the 1997-2003 series is
calculated using NAICS 311 (Food manufacturing) and NAICS 3121 (Beverage manufacturing).
15
Because retailers do not adequately take
account of manufacturer profitability on
incremental sales in deciding on product shelf
space allocation.
1. Retailers will not have the incentive to stock the
“right” products, i.e., the products that maximize the
joint profit of the manufacturer and retailer.
•
retailers will allocate shelf space across products so
dQ
that retailer incremental profit, or dSR (PR – MCR), is
approximately the same across all products.
16
2.
Even if every product had the same
manufacturer margin and the same effect of shelf
space on its impulse sales, each manufacturer
would desire that increased promotional shelf
space be provided for its products, increasing the
value of retailer shelf space.
•
This does not mean that retailers will earn
extra profit.
17
The Efficient Form of Slotting Contracts
1.
a retailer premium to cover the cost of
supplying the promotional shelf space
must be created
•
•
easier to accomplish with per unit time payment
but possible with lower wholesale price
2.
there may be large manufacturer
efficiencies associated with a lower
wholesale price
3.
shelf space and exclusivity
18
Conclusions
• This paper provides a pro-competitive justification –
resolving incentive conflicts over the provision of
promotional services -- for manufacturer purchase of
retail shelf space
• The antitrust experience with slotting contracts in the
United States appears to confirm the historical
tendency to condemn business practices before they
are sufficiently well understood
19