This paper argues that revenue sharing is a valuable instrument in vertically-separated industries when there is intrabrand competition among the downstream firms, demand is stochastic or variable, and downstream inventory is chosen before demand is realized. In these environments, the upstream firm would like to simultaneously soften downstream competition and encourage efficient inventory holding. Traditional twopart tariffs cannot achieve both objectives in the presence of downstream competition. Raising the price of the inputs softens price competition but distorts the downstream firms' inventory decisions. We argue that revenue sharing, combined with a low input price, aligns the incentives in the vertical chain. The application of revenue sharing in video retailing is discussed. Keywords: Vertical Separation, Vertical Restraints, Royalties, Revenue Sharing, Double Marginalization, Input Substitution, Demand Uncertainty. j-dana@nwu.edu, k-spier@nwu.edu. Department of ...
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