Revenue Sharing and Vertical Control in the Video Rental Market

Revenue sharing contracts, in which retailers pay a royalty on sales to their suppliers, are now widely used in the video rental industry. We show that revenue sharing is valuable in vertically-separated industries in which demand is either stochastic (unpredictable) or variable (e.g., systematically declining), downstream inventory is chosen before demand is realized and downstream firms engage in intrabrand competition. Unlike two-part tariffs, revenue sharing achieves the first best outcome by softening retail price competition without distorting retailers