A retailer guarantees the lowest price, but it ends up costing consumers more.

Wait, what?

It’s counterintuitive, but it can happen when a retailer pairs a low-price commitment with a contract requiring suppliers to protect its profit margin.

That outcome is at the heart of research by Leela Nageswaran, Assistant Professor of Operations Management at the Foster School of Business. The paper, “Anti-competitive Effects of a Dominant Retailer’s Guaranteed Profit Margin and Low-Price Contracts,” is forthcoming in Management Science.

The contract behind the promise

The research was sparked by a 2022 antitrust lawsuit brought by the California attorney general over Amazon’s retail practices. Nageswaran and her co-authors focused on Amazon’s use of guaranteed-margin contracts for products it purchases from suppliers and sells directly to consumers.

Suppose Amazon buys a sweater from a supplier and requires a profit margin of at least $6 on every sale. If a competitor sells the sweater for less, Amazon may lower its price to match. But if that reduces its margin to $4, the supplier must repay the missing $2 for every unit sold.

For the retailer, the arrangement limits risk. For the supplier, it makes profits less predictable and creates an incentive to prevent lower prices from appearing elsewhere.

“Take the product away from Walmart and elsewhere so that there’s no comparison at all,” Nageswaran says. “That appears to be an easy solution, but think about it from the consumer’s perspective.”

With fewer retailers selling the product, consumers lose the ability to shop around, and competition no longer exerts the same downward pressure on prices.

The subject was timely, but Nageswaran was surprised that few papers existed at the intersection of supply chains and antitrust. 

A game of retail rock, paper, scissors

To understand how a single contract could reshape an entire market, the researchers built a game-theoretic model featuring one supplier and two competing retailers. Each firm tries to maximize its own profit while anticipating how the others will respond.

Nageswaran compares the process to rock, paper, scissors. The supplier decides whether to sell through one retailer or both. The retailers set their prices. Consumers decide where, or whether, to buy.

The researchers compared three arrangements: traditional wholesale contracts, guaranteed-margin contracts, and guaranteed-margin contracts paired with a commitment to offer the lowest price. Their model allowed them to trace not only what one company would do, but how that decision would change the incentives facing everyone else.

When guaranteed margins help—and when they hurt

What they found was more nuanced than either side of the legal debate suggested.

The biggest factor was the intensity of competition in the product category—in other words, how readily shoppers will switch retailers to get a lower price.

A guaranteed-margin contract by itself is not necessarily bad for consumers. When shoppers are less likely to switch retailers, as they may be for niche products or brands with loyal customers, it can lead to lower prices and wider availability than a traditional wholesale arrangement.

But when shoppers readily switch retailers based on price, as they often do for interchangeable mass-market goods, the contract can push the supplier toward an exclusive relationship with the retailer. That leaves consumers with fewer places to buy the product and, ultimately, higher prices.

The line becomes clearer when the retailer pairs the guaranteed-margin contract with a commitment to match the lowest price. In the researchers’ model, combining the two practices consistently raised prices and reduced the number of consumers who bought the product. Instead of sharpening competition, the lowest-price promise dampened it by encouraging the retailers to settle at the same higher price.

Nageswaran was surprised by how well that central finding held up as the team tested different assumptions about what each retailer knew, how prices were set, and whether suppliers could charge different wholesale prices to the retailers.

“It’s remarkable that the core result is just so robust that it is withstanding all these additional dimensions,” she says.

Why regulators should look beyond the contract

For regulators, the research argues against treating all guaranteed-margin contracts alike.

“There are some product categories where you should actually encourage it,” Nageswaran says. “You should not just shut it down.”

Because the contract can lower prices and expand availability in less competitive categories, regulators could end up hurting consumers by banning it across the board. Highly competitive categories deserve closer scrutiny, particularly when a guaranteed margin is paired with a lowest-price commitment.

The research also points to another regulatory lever: whether suppliers can charge competing retailers different wholesale prices. When the researchers allowed those prices to vary, the potential consumer benefits of guaranteed-margin contracts disappeared.

Suppliers have their own trade-offs to consider. In the model, traditional wholesale contracts were consistently the most profitable option for them. In practice, however, Nageswaran says suppliers may be willing to accept somewhat lower profits in exchange for benefits the model does not capture, including access to Amazon’s scale and data. Over time, they may also be able to negotiate the required margin or structure the relationship so the retailer shares more of the risk.

The research therefore offers something different to each stakeholder: guidance for regulators deciding where to intervene, a warning for suppliers evaluating contract terms, and a clearer picture for consumers of why a promise that sounds beneficial may not work as expected.

Showing students how one decision reshapes a system

Nageswaran brings the research into her introductory undergraduate supply chain and operations management course.

Students begin with a simple model of one supplier and one retailer, showing how each can make rational decisions yet leave the overall supply chain worse off. She then connects that lesson to the Amazon example, demonstrating how one company’s choice can change everyone else’s incentives.

A promise to offer the lowest price seems incapable of raising prices until students account for how suppliers and competing retailers will respond.

“How can the fact that we want to be the lowest price ever increase prices?” she asks. “Well, yes, I will show you how. It is because your actions affect somebody else’s actions.”

The larger lesson is to consider the incentives and likely reactions of everyone involved, rather than examining a single company’s decision in isolation.

“That information and that way of thinking is gold,” Nageswaran says.

The next pricing puzzle

Since earning tenure earlier this year, Nageswaran says she has been thinking more deliberately about how her work can reach beyond academic journals. 

“You want your papers to be read, you want your work to be impactful,” she says. “I have to step out of my comfort zone.”

The same question that drove this research is now leading her into new territory: What happens when prices and purchasing decisions are increasingly shaped by algorithms and AI?

She is studying how dynamic pricing and AI agents that steer product searches and recommendations may change what consumers see, what they buy, and how retailers and suppliers respond. Those technologies are “fundamentally reshaping how prices are set, which products are being bought, and which products are being suggested,” she says.

The tools may be new, but the challenge is familiar: understanding how one seemingly beneficial decision can ripple through an entire marketplace.

Leela Nageswaran is an Assistant Professor of Operations Management at the University of Washington Foster School of Business. Nageswaran was named one of the “Top 50 Undergraduate Professors of 2022” by Poets & Quants for producing an extraordinary set of preparatory materials for her Foster School Operations Management classes to contextualize concepts, then delivering them authentically and in a spirit of inclusion.