Channel of distribution profits when channel members form conjectures

It is well known that lower channel profits are achieved in the bilateral (manufacturer-reseller) monopoly if manufacturer and reseller independently optimize their respective profits: They take each other’s decisions as given i.e., adopt decision rules that ignore their influence on the other channel member. Higher profits are achieved if they coordinate their profit maximizing decisions. Consequently, there is an economic justification for (1) vertical integration that by definition prevents conflicting profit objectives or (2) contracts that change channel members’ incentives to the compatible objectives of shares of total channel profits. This paper investigates the possibility that coordination might take place without formal arrangements like vertical integration or contracts. The reason for this contention is the casual observation that channel members are often acutely aware of the interdependencies between the channel participants. We might thus expect that they will form conjectures about other channel members’ reactions to their own actions. We show that rational conjectures lead profit maximizing channel members to adopt modified decisions rules. Can such conjectural decision-making create, at least partially, channel coordination or cooperation? In other words, can channel members deviate from the Nash equilibrium and thus achieve greater profits? The answer given