Channel Dynamics Under Price and Service Competition

Abstract

This paper studies a distribution system in which a manufacturer supplies a common product to two independent retailers, who in turn use service as well as retail price to directly compete for end customers. We examine the drivers of each firm's strategy, and the consequences for total sales, market share, and profitability. We show that the relative intensity of competition with respect to each competitive dimension plays a key role, as does the degree of cooperation between the retailers. We discover a number of insights concerning the preferences of each party regarding competition. For instance, there will be circumstances under which both retailers would prefer an increase in competitive intensity. Our analysis generalizes existing knowledge about manufacturer wholesale pricing strategies, and rationalizes behaviors that would not be evident without both price and service competition. Finally, we characterize the structure of wholesale pricing mechanisms that can coordinate the system, and show that the most commonly used formats (those that are linear in the order quantity) can achieve coordination only under very limiting conditions.