|Abstract:||Manufacturers often offer trade promotions such as markdown allowances as incentives to retailers. These savings, if passed onto consumers in the form of lower retail prices, can stimulate consumer purchases and thus enhance the manufacturers' profits. Retailers, however, may not pass savings onto consumers, thus rendering markdown allowances ineffective in generating sales. It is suggested that this problem could be overcome by designing an incentive scheme based on the retailer's total markdown cost. This research addresses the above problem by examining the optimal structure of the manufacturer's markdown sharing policy which maximizes the manufacturer's expected utility of profit in an uncertain market. In particular, this research evaluates three commonly used markdown sharing policies by manufacturers in the industry, and focuses on three specific issues: (a) how the manufacturer's price and markdown sharing policy affect the retailer's pricing and markdown decisions, (b) how market uncertainty affects the decisions of the manufacturer and the retailer, and (c) how the retailer's use of simplifying heuristics, such as a constant markup rate and a constant markdown percentage, affects their decisions. A single-period Stackelberg game, where the manufacturer is the leader and the retailer is the follower, is used to develop a theoretical model explaining the interaction of channel members. The manufacturer first declares the price he will charge the retailer and his markdown sharing policy. The retailer then decides the initial retail price and the markdown percentage. It is shown that by linking the markdown allowance to the markdown taken by the retailer, the manufacturer can exercise greater control and thus obtain more profit at the expense of the retailer. The retailer, however, can counteract the manufacturer's manipulation by subscribing to simple decision heuristics such as a high constant markup rate and a low constant markdown percentage. Also, it is shown that the manufacturer has to sacrifice some profit to the retailer in order to elicit the retailer's cooperation in coping with market uncertainty. As the channel members become less certain of consumer demand, the adjustments in their decisions benefit consumers as whole by offering them more savings.