How to elicit sequential retailer information optimally

In vertical relationships, manufacturers commonly rely on retailers to sell their goods. In this note, we analyze a manufacturer–retailer relationship in which a manufacturer delegates the sale of his product to a retailer who gets sequentially private information about the retail value of the product. At the time of contracting the retailer knows only the product’s expected retail value, but subsequently learns the actual valuation. As a result, the retailer is tempted to understate the product’s (expected) value in order to receive more favorable pricing conditions from the manufacturer. In this note, we characterize the optimal sequential screening contract using ex-post and ex-ante incentive constraints. Furthermore, we discuss the mechanism’s properties. Moreover, we show how the optimal mechanism can be induced with two-part tariffs and with contracts based on returns. This allows us to discuss briefly which combination of the different instruments – returns, price floors, ex-ante and ex-post pricing – optimally elicits the retailer’s private information.