Secret Two-Part Tariffs and Retailer Risk Aversion

Abstract This paper studies a manufacturer that offers secret two-part tariffs to multiple retailers that compete in prices. Prior work on this setting has shown that, in equilibrium, wholesale prices equal marginal cost and profits vanish as retailers become undifferentiated. I extend the prior work by introducing demand uncertainty and downstream risk aversion. I show that if merely a single retailer is risk averse, all wholesale prices will lie above marginal cost. Intuitively, the manufacturer provides insurance to the risk-averse retailer by reducing its fixed fee and increasing the wholesale price above cost. The positive upstream margin in turn induces the manufacturer to divert sales toward the risk-averse retailer, which it does by increasing wholesale prices for the risk-neutral retailers as well. Relatedly, downstream risk aversion can increase industry and upstream profits compared to risk neutrality if retailers are close substitutes.