Innovation and Distribution: an Equilibrium Model of Manufacturing and Retailing

Abstract

This paper proposes a model of the distribution channel to study the decisions of manufacturers, retailers and consumers. The model is used to study how retail distribution affects manufacturing and consumers. As the cost of distribution falls, the retail sector increases assortment size and allows a larger mass of manufacturers to enter, allowing consumers to buy more variety. Entry primitives in manufacturing and retailing determine vertical pricing power. The equilibrium of the model predicts the national retail sector is a fraction of the total economy that depends on the demand for variety. It is not affected by, e.g., consumer transportation cost or income. Data support this prediction.