This research examines the behavior of manufacturers and retailers in the presence of merchandising allowances. Merchandising allowances are fees manufacturers pay retailers to encourage them to allocate certain in-store promotional activities to the manufacturers' brand. According to estimates, retailers collect billions of dollars in these allowance payments annually. Using a three-stage game, I formulate a vertical structural model that endogenously models manufacturer, retailer, and consumer behavior. Manufacturers compete with each other, using merchandising allowance payments, in order to obtain premium shelf space at retail outlets. Retailers, given allowance offers, choose display configurations and then set retail prices. Consumers observe the display and retail prices and determine whether to purchase one or no units of the good. I estimate the model with a method of moments technique using IRI scanner data from the ketchup industry. In addition to estimating consumer tastes parameters, the model yields predictions of the underlying wholesale prices and the merchandising allowances each manufacturer offers. I use the parameter estimates to conduct a counterfactual simulation of how agents might respond when the use of merchandising allowances is no longer permissible. I find that while merchandising allowances increase retail profits, total welfare is lower due to the allowances.


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