The underexplored impacts of online consumer reviews: Pricing and new product design strategies in the O2O supply chain
Introduction
The E-commerce giants Amazon, Alibaba Group, and JD.com have realized the importance of building an ecosystem of retail partners and consumers and had their local stores to start their O2O(online to offline) strategies in the post-COVID-19. Most FMCG (Fast Moving Consumer Goods) retailers have intensified their O2O services through self-run platforms, such as WeChat mini-programs or closer cooperation with Vanguard, JD.com, RT-mart, Wal-Mart and Dmall etc. Far more consumers are adjusting their daily routines and shopping online now as compared to the pre-COVID era. In the second quarter of 2020, 30% of Chinese urban families purchased FMCG through O2O platforms.2 This change requires FMCG companies to renew their channel-management approaches, including how they assort, price and promote their products. For example, many winning FMCG companies such as Three Squirrels and Conagra Foods have been renovating in their sub-category by deploying consumer-back analytics, imbuing them with more relevance to meet consumer needs, although they have a success of their incumbent products. One of the fasting growth instant-noodle brand RamenTalk founded in 2016 from China achieved 250 million yuan (30 million dollars) in 2019. Its essential successful strategies are to compress the time of launching the new product within two months from identifying the consumers' preference, pre-test, package design and production to the market and apply Word-of-mouth (WOM) to facilitate the products' sales.3 Intuitively, Word-of-mouth increases the products' sales, but intensifies the intra-brand competition between the new product and the incumbent product. As the rapid development of a new product is a crucial strategy for success in the FMCG industry, marketers should pay more attention to this loss caused by such intra-brand competition when new product entries. Therefore it is critical to figure out whether Word-of-mouth brings a positive or negative effect on the manufacturers' and the platform sellers’ profits and how to manage these effects in the FMCG O2O supply chain.
Consumers' evaluations of such experience products tend to be idiosyncratic, so the popularity of a product or other users' experience become more important for consumers as indicated by the volume of consumer reviews and detailed experience description from users' reviews. An increasingly dominant market strategy for retailers to boost new product sales is to make online consumer reviews available on their websites (Chevalier and Mayzlin, 2006; Pradeep et al., 2010). To have a sales-increased effect, sellers on Amazon or JD.com send an email or leave a message on the order webpage to ask reviews that increase the number of online reviews (volume and valence) (FloydRyan et al., 2014; You and VadakkepattAmit, 2015). They guide the content of reviews and respond reviews to improve the rating and win back consumers’ trust. In a recent paper, Dost et al. (2019) prove that WOM has a positive effect on the sales of FMCG.
While considering the effect of consumer reviews on the product line with different margins, marketers need careful consideration of the information-driven cannibalization problem. When a product line extension is implemented from one sub-category to another sub-category, there is an internal competition of a part of the former's sales being squeezed by the latter or reversely. When the new product enters the market, the marketer often ignores that the incumbent product's demand-generating information helps it squeeze the market share of the new product with a higher margin. It decreases the profit from the new product. Most FMCG companies sell millions of packs of food every year. Even a small part of consumers switch to the incumbent product from the new product with a higher margin, the accumulation of such switching loss costs hundreds of thousands of dollars a year. This is because such cannibalization happens very often in FMCG industry due to the fast new product development strategy. One of the approaches to control such information-driven cannibalization is to limit the reviews' (R) increased-sales effect (E) on the incumbent (I) product (RE-I hereafter).4 Part of consumers would stop switching from the later to the former. Most literature on online reviews emphasizes its positive impact, but this paper extends the study on its negative aspect driving the intra-brand competition. We first ask whether platform sellers should differentiate consumer reviews' management for their product portfolio to soften such cannibalization.
Manufacturers often free ride retailers' marketing effort facilitating sales to enjoy the benefits. However, they also incentivize retailers' provision of demand-generating services by providing the compensation, when the retailers' income from the increased sales of marketing effort cannot offset its provision cost. For example, auto manufacturers sometimes compensate car dealerships for consumer test drives (Kuksov and Liao, 2018). We have the similar logic to study the conflict between the manufacturers and their platform sellers (one acquires the benefit, but the other gets the hurt), but this paper explores whether the increased-sales effect of consumer reviews leads to the conflict from the information-driven cannibalization aspect, rather than the cost offset mechanism. Then, we ask how manufacturers compensate their sellers by controlling the product line's wholesale prices to affect platform sellers' strategy on managing consumer reviews.
An interesting finding from the recent paper (Godes, 2017) shows that WOM's expansion may decrease the optimal product quality. He suggests the firm's product policy may require reconsideration with the implications of the growth of social interactions. The relation between the new product design and social communication is bidirectional. We aim to extend the analysis to study how manufacturers' new product design affects the platform sellers' consumer reviews strategy to solve the conflict problem and improve the FMCG O2O supply chain.
As the fast launching of the new product to meet consumers' new preference and the application of WOM attracting consumers are important strategies for the success, FMCG O2O chain members need to balance the product line's sales (the new product and the incumbent product) rather than the sales of a single product and consider the competition from other brands affecting these sales. They should also consider the interaction between the platform sellers' consumer reviews strategy for the product line and the manufacturers' possible strategy on the wholesale prices or the new product design. In this work, we model FMCG O2O decentralized chain with a Stackelberg sequential game where the manufacturer acts as leader and platform seller as a follower. By considering the information-driven cannibalization from the incumbent product against the new product, the platform sellers decide whether limit consumer reviews' increased-sales effect on the incumbent product (RE-I) that soften the intra-brand competition. First our analysis examines how RE-I causes the conflict between the manufacturer and his platform seller in the O2O FMCG supply chain. One of the results is that the FMCG manufacturer always benefits from RE-I. The platform seller, on the other hand, only benefits from RE-I under certain conditions. Then we show the conditions where the manufacturer can distort wholesale prices of the whole product line or lower down the new product quality to direct the platform seller towards RE-I to coordinate the channel.
This study has two important theoretical contributions. First, this study extends the previous literature on consumer reviews by considering consumer reviews' impacts on the sales and the intra-brand competition for the product line. Past research usually focuses on the increased-sales effect of consumer reviews but does not consider its effect on intensifying the intra-brand competition that harms the profit. The previous literature does not reflect the business practices as most FMCG firms apply the fast new product development strategy for success and it causes the severe intra-brand competition between the new product and the incumbent product. Second, the past O2O supply chain management literature has considered the conflict conditions where the market return cannot offset a high marketing investment but unfortunately ignores that the intra-brand competition intensified by sellers' online reviews strategy causes the conflict. Further, we contribute to this literature by presenting a new method to coordinate the channel. In particular, manufacturers can increase their profits through adopting new product design strategy to influence the platform sellers’ online reviews strategy.
We yield several important practical implications for the coordination of the decentralized FMCG O2O supply chain, when the manufacturers launch the new product and distribute products through the platform sellers. When consumers' valuation for the new product is higher enough, the reviews' increased-sales effect on the incumbent product causes the conflict. Based on that, we provide new insights for the manufacturers' strategies to coordinate the channel. (i) When consumers' valuation for the new product is relatively high (higher enough), the manufacturers should compensate the platform sellers by reducing the product line's wholesale prices and the platform sellers apply the same consumer reviews strategy for the product line. (ii) When consumers' valuation is relatively low (higher enough), the manufacturers should lower down the new product quality to stimulate the same consumer reviews strategy for the product line from the platform sellers.
The paper is organized as follows. Section 2 reviews the related literature. Section 3 outlines the model and introduces the benchmark model. Section 4 models the impact of RE-I on the cannibalization of new products, in which we discuss the interaction between the manufacturer and the platform seller through their control on the product quality, pricing and the strategy on managing consumer reviews. Possible extensions of the model are presented in Section 5. Finally, the study concludes in Section 6 with a summary of the main findings. The corresponding proofs are in the appendix.
Section snippets
Literature review
The research questions addressed in this paper relate mostly to the literature on online consumer reviews. As several studies have empirically shown that more favourable reviews or rating environment can directly improve sales (Moe and Trusov, 2011; Mayzlin et al., 2014), and the social welfare generated by review systems can improve consumer choice (e.g. Duan et al., 2008). In the extant literature, the impact of product reviews on sales is typically measured using numeric variables that
The model
Consider a market in which there are two differentiated FMCG substitute products produced by two manufacturers. Product a produced by manufacturer A is sold online directly to consumers; product b produced by manufacturer B is distributed through a platform seller. With consumer-back analytics, manufacturer B knows consumers' new preference and considers launching a new product to satisfy them, , into the market. He decides the quality of the new product and sets the new and the incumbent
The platform seller's management strategy on consumer reviews
In this section, we first study the effect of consumer review on the platform seller's and the manufacturer's profit. We start by assuming that the manufacturer does not respond to the change in the reviews strategy by the platform seller, and later we allow the manufacturer can adjust his strategies to affect the platform seller's reviews strategy. The platform seller limit the reviews' increased-sales effect on the incumbent product (RE-I) where the manufacturer does not take any action in
The effect of the product differentiation change on RE-I strategy
We have so far assumed that the products are located at an equal distance from one another. We now turn our attention to the case where the new product is more similar to the incumbent product than the competing product. This refinement makes obsolete the assumption of equidistance between product locations. To be able to capture the closeness in substitutability we introduce a new parameter , which defines how much closer or farther away the new product is to the incumbent product
Conclusions
It is widely agreed that apply online consumer reviews is the dominant market strategy to boost product sales. Interestingly, we have identified its negative effect on driving the intra-brand competition and how it leads the conflict between the platform seller and his manufacturer. We also have studied the possible compensation mechanism of the manufacturer through the balance of his product line's income and how his new product design affects the platform seller's consumer reviews strategy to
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The first corresponding author is Prof. Yu Xiong, University of Surrey, UK; The second corresponding author is Dr. Senmao Xia, Coventry University, UK.