Abstract
We develop a theoretical model to investigate the incentives for coordinating the positioning and pricing of horizontally differentiated products in the context of a vertical trading relationship between a retailer and multiple suppliers. We also use the model to analyze various trading relationships, such as category management, and characterize the channel efficiency of each, leading to interesting insights about when such practices may be most effective. In particular, we show that when competing suppliers sell through a common retail intermediary, the classical neo-Hotelling incentives to differentiate products is eliminated (or significantly reduced) in certain channel added value regimes, resulting in a loss in channel profit. The incentives to differentiate are recovered, however, if all products are controlled by a single supplier as in category management. Depending on the channel added value regime, the gain in efficiency from a monopolist supplier's incentive to differentiate can offset the loss in efficiency due to positioning distortion and cost difference distortion. These results provide a theoretical explanation for why category management may lead to gains in supply chain efficiency. Lastly, we show numerically how category management together with a simple profit target for the retailer can, in many cases, achieve both full supply chain coordination and a Pareto improving allocation of profits to both the supplier and retailer.