Abstract The formation mechanism and welfare effects of slotting allowances is still a hot topic in academia. However, there is little study on the effects of retailers’ commodity quality towards transaction terms between market participants. Based on the reality of business negotiations between retailers and suppliers and a classical utility function, this paper has established an upfront payment model which contains product qualities and bargaining power and investigate the formation and operation mechanisms as well as market effects of slotting allowances. In addition, this paper also analyzes the practical basis of the upfront payment model and investigates some exceptional cases. The result shows that, when the upfront payment is a rigid contract arrangement, the formation of slotting allowances depends on retailers’ product quality and bargaining power simultaneously, and only retailers with low product quality and low bargaining power cannot charge fees. If retailers make decisions on contract structures and choose upfront payment contracts finally, slotting allowances will be the only outcome in equilibrium. For manufacturers, slotting allowances can be a quality screen mechanism by force for the low quality firms to exit. This screen mechanism also determines the gains and losses of consumers’ surplus under slotting allowances.
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