While retailers have sales data to forecast demand, manufacturers have a broad understanding of the market and the coming trends. It is well known that pooling such demand information within a distribution channel improves supply chain logistics. However, little is known about how information-sharing affects wholesale pricing incentives. In this paper, we investigate a channel structure where a manufacturer and two retailers have private signals of the state of the demand. Our model identifies the presence of a pricing distortion, which we term the inference effect, when a manufacturer sets price to an uninformed retailer. Because of this inference effect, the manufacturer would like to set a low wholesale price to signal to the retailer that the demand is low. On the other hand, the manufacturer would like to set a high wholesale price so that he earns the optimal margin on each unit sold. Vertical information sharing benefits the manufacturer by eliminating the distortion caused by the inference effect, which is more profound in a channel whose retailer has a noisier signal. This result implies that when there is a cost associated with transmitting information, the manufacturer may choose to share information with only the less-informed retailer rather than with both.
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