Manufacturer encroachment with equal pricing strategy

https://doi.org/10.1016/j.tre.2021.102346Get rights and content

Highlights

  • This study investigates the interplay between manufacturer encroachment and equal pricing.

  • The availability of equal pricing may enhance the manufacturer’s incentive to encroach.

  • The equal pricing commitment can hurt the retailer even though it eliminates price competition.

  • The equal pricing commitment sometimes benefits both the manufacturer and retailer.

Abstract

This study investigates the interplay between manufacturer encroachment and the manufacturer’s equal pricig strategy. Encroachment happens when a manufacturer opens up a direct channel to compete with a retailer’s traditional channel. The equal pricing strategy is that the manufacturer commits to setting a direct channel retail price that equals the price determined by the retailer in the traditional channel. We first consider the setting where one exclusive retailer sells products from a manufacturer that does not have the option of selling only through its direct channel. Our results show that the availability of the equal pricing commitment enhances the manufacturer’s incentive to encroach when the channel competition is intense and the encroachment cost is medium. Interestingly, the manufacturer’s equal pricing commitment always hurts the retailer even though it eliminates the price competition between the two channels. This is because the availability of the equal pricing commitment could motivate the manufacturer’s encroachment. Our analysis shows that the manufacturer’s equal pricing commitment always improves consumer surplus and sometimes improves the supply chain performance. However, when the retailer also sells a substitutable product from a different manufacturer or the manufacturer has the option of only direct selling, the equal pricing commitment sometimes benefits the retailer and sometimes reduces the consumer surplus.

Introduction

Upstream manufacturers have competed with downstream retailers for many years by introducing a direct channel and selling directly to consumers. This phenomenon is called manufacturer encroachment, supplier encroachment, or supply chain encroachment in the literature (Kalnins, 2004, Arya et al., 2007, Li et al., 2013, Li et al., 2015, Li and Zhou, 2016, Zhang et al., 2021). Due to the rapid development of third-party logistics and information technology, it is easy for manufacturers to provide a convenient and secure direct sales channel (Matsui, 2017). Many manufacturers have introduced direct channels, such as Dell and Cisco in the computer industry, Nike and Adidas in sporting goods, and Sony and Samsung in consumer electronics (Hsiao and Chen, 2014). The dual-channel supply chain with manufacturer encroachment has become an increasingly important issue in the field of logistics and supply chain management from both academic and practical perspectives (Liu et al., 2016, Li et al., 2018, Huang et al., 2018, Li et al., 2019, Xue et al., 2020).

In practice, when manufacturers open up direct channels, some manufacturers commit to setting the same retail prices in their direct channels as those determined by the retailers in traditional channels (Cattani et al., 2006, Zhou et al., 2018), which in our work is termed the equal pricing strategy. The equal pricing strategy is adopted by many upstream suppliers in the air transportation industry. For example, airlines such as Air Canada, Air France, American Airlines, British Airways, Continental, Delta, United, and US Airways promise to match the price of the retailers (e.g., Expedia, Travelocity, and Priceline) in their direct channels (Nalca et al., 2020). In another example, Dell adopts the equal pricing strategy, and the internet prices of its laptops for every model sold on its own website equal the in-store prices charged by the retailer (Ding et al., 2016). In practice, the credibility of an equal pricing commitment is sustained by some external commitment device, such as contractual arrangements or the manufacturer’s reputation concerns (Hadfield, 2008). Contractual arrangements between the manufacturer and the retailer, including provisions that prevent the manufacturer from adjusting its direct channel price, can be used by the manufacturer to convey a credible commitment to equal pricing. Alternatively, the direct channel price is verifiable, so the manufacturer may be averse to adjust its price due to reputation concerns. For example, because of the contractual arrangements or reputation concerns, airlines (e.g., Air Canada, Air France) and Dell can convey a credible equal pricing commitment. In Table 1, we display a recent survey of prices of popular products and show that the manufacturers’ internet prices and the retailers’ in-store prices are almost the same. These in-store prices are determined by the traditional retailers (e.g., Walmart, Macy’s), and the manufacturers match the retailers’ prices in their direct channels.

Although some manufacturers use the equal pricing strategy, others do not, including Sony and LEGO. The Sony KD-65U8G 65” TV can be obtained for ¥8999 at JD.com, which is the leading Chinese online retailer (Tian et al., 2018), while the retail price for this TV determined by Sony in its direct channel is ¥9499; the retail price for LEGO Super Heroes 76115 at the Walmart Cicero Store in Illinois is $39.73 while the retail price in LEGO’s direct channel is $49.99.1

If the equal pricing strategy is adopted, the manufacturer commits to keeping the retail price for its direct channel identical to the price in the retailer’s channel. This means that the retailer can determine the retail prices for both channels, so price competition between the two channels does not exist and channel conflicts are alleviated. From the manufacturer’s point of view, the direct channel retail price cannot be optimized because of the equal pricing commitment. Moreover, the manufacturer makes the encroachment decision considering whether to adopt the equal pricing strategy. From the retailer’s point of view, the retailer can determine the retail prices for both channels when the manufacturer adopts equal pricing, but the availability of the equal pricing commitment may change the manufacturer’s encroachment decision. Therefore, the equal pricing strategy in supply chain encroachment motivated by industry practices raises the following questions: (i) When should the manufacturer encroach, and if so, should it adopt the equal pricing strategy? (ii) How does the availability of the equal pricing commitment affect the manufacturer’s encroachment decision? (iii) What is the impact of the manufacturer’s equal pricing commitment on the retailer, total supply chain, and consumer?.

To address these questions, we build a game-theoretic model consisting of one manufacturer that introduces a direct channel to compete with a retailer’s channel and incurs an encroachment cost for selling directly to consumers. The manufacturer first decides whether to encroach and then determines whether to adopt the equal pricing strategy if the manufacturer encroaches. We first consider the exclusive reselling environment where one manufacturer sells through an exclusive retailer and the manufacturer cannot sell only through its direct channel. The interaction between the manufacturer’s encroachment decision and the equal pricing strategy is analyzed in our work, producing the following main findings.

First, the manufacturer adopts equal pricing only when the channel competition intensity is high and the encroachment cost is medium. This is because the equal pricing commitment is a double-edged sword from the manufacturer’s standpoint: although it eliminates price competition between the two channels to mitigate channel conflicts, the manufacturer cannot determine its direct channel price. When the channel competition is intense and encroachment cost is medium, the encroachment cannot bring the manufacturer a higher profit if the manufacturer does not use the equal pricing strategy to mitigate channel conflicts. Thus, in this case, the manufacturer encroaches and adopts equal pricing, and the encroachment can increase the manufacturer’s profit.

Second, the availability of the equal pricing commitment may enhance the manufacturer’s incentive to encroach. Specifically, the availability motivates the manufacturer to encroach when the channel competition is intense and encroachment cost is medium. Encroachment not only generates a new revenue stream for the manufacturer through direct sales but also brings channel competition. When the channel competition is intense and encroachment cost is medium, the manufacturer has no incentive to encroach if the manufacturer cannot credibly commit to equal pricing to mitigate channel conflicts. If, however, the equal pricing strategy is an option, then the manufacturer will encroach and adopt equal pricing.

Third, the impact of equal pricing is analyzed from the differing perspectives of the retailer, total supply chain, and consumer. The equal pricing commitment always harms the retailer’s profit. This happens because, when channel competition is intense and encroachment cost is medium, the availability of the equal pricing commitment motivates the manufacturer’s encroachment, which harms the retailer. Note that the equal pricing strategy is adopted by the manufacturer only when it brings the manufacturer a higher profit. Therefore, the equal pricing commitment improves the profit of the total supply chain when the positive effect on the manufacturer dominates the negative effect on the retailer. Moreover, the equal pricing commitment always improves the consumer surplus because the availability of the equal pricing commitment can motivate the manufacturer to encroach, and that brings channel competition.

Finally, we consider the settings of (1) a nonexclusive retailer that sells a partial substitute from a different manufacturer, and (2) a sole channel of direct selling where the manufacturer has an option of selling products only through its direct channel (i.e., no longer selling through the retailer). When the manufacturer sells through a nonexclusive retailer, the equal pricing commitment sometimes benefits the retailer. This is because the existence of a second product sometimes motivates the manufacturer to adopt equal pricing without changing its encroachment decision. Besides, equal pricing sometimes benefits the supply chain and sometimes reduces the consumer surplus. When the manufacturer has the option of selling only through the direct channel, the manufacturer’s equal pricing commitment sometimes benefits the retailer because the manufacturer may switch from only direct selling (which would cut out the retailer completely) to encroachment while adopting the equal pricing strategy. Additionally, the equal pricing commitment sometimes benefits the supply chain and sometimes reduces the consumer surplus.

This paper makes the following specific contributions:

(1) Our work contributes to the literature on manufacturer encroachment, which has become an increasingly important issue in the field of logistics and supply chain management. Although manufacturer encroachment has been becoming increasingly popular due to the rapid growth of online direct selling, few studies have considered the interaction between manufacturer encroachment and equal pricing. This research fills this research gap in the encroachment literature by incorporating the equal pricing strategy into the manufacturer’s encroachment decision.

(2) This research focuses on the impact of the equal pricing strategy and shows new results with different driving forces. Previous work (Cattani et al., 2006) assumes the equal pricing commitment to be an exogenous constraint and shows that the equal pricing constraint always hurts the manufacturer and benefits the retailer because the equal pricing constraint does not allow the manufacturer to set an optimal direct channel price. Cattani et al. (2006) explain the phenomenon of equal pricing commitment from the viewpoint of channel conflicts, i.e., equal pricing sometimes mitigates the channel conflict without greatly sacrificing manufacturer profits. However, we characterize the interaction between the equal pricing strategy and the encroachment decision. Our work shows that the equal pricing commitment always benefits the manufacturer and sometimes hurts the retailer because the availability of the equal pricing commitment changes the manufacturer’s encroachment decision. Our work explains the phenomenon of the equal pricing strategy from the viewpoint of the manufacturer, i.e., the equal pricing commitment can motivate the manufacturer to encroach when the encroachment cost is medium and the channel competition is intense, which brings the manufacturer a higher profit.

(3) Our results provide useful managerial implications for the manufacturer and the retailer. The manufacturer should reduce (raise) the wholesale price as the encroachment cost goes up when the manufacturer encroaches without (with) equal pricing. Besides, the manufacturer should convey an equal pricing commitment when the channel competition is intense and the encroachment cost is medium. Additionally, the equal pricing commitment always hurts the retailer if the retailer is exclusive and the manufacturer does not have the option of only selling through its direct channel. However, the equal pricing commitment sometimes benefits both the manufacturer and the retailer in the settings of a nonexclusive retailer and sole channel of direct selling, which illustrates the value of the equal pricing commitment in the dual-channel supply chain with manufacturer encroachment.

The remainder of this paper is organized as follows. We review the related literature in Section 2. Section 3 introduces the key elements of our model, and Section 4 analyzes the game equilibrium. Section 5 compares the equilibrium solutions across various scenarios and then investigates the impact of the equal pricing commitment from the perspectives of the retailer, total supply chain, and consumer. Subsequently, Section 6 considers model extensions with a nonexclusive retailer who also sells a second product from a different manufacturer; a sole direct selling channel in which the manufacturer has the option of selling only through its direct channel; and two different pricing sequences: the manufacturer determines the retail price of its direct channel before or after the retailer makes its retail pricing decision when the manufacturer encroaches without equal pricing. Finally, the paper concludes in Section 7. All equilibrium solutions are summarized in Appendix A and all mathematical proofs are provided in Appendix B of the online appendix.

Section snippets

Literature review

Our paper is closely related to the literature on the dual-channel supply chain with manufacturer encroachment. Chiang et al. (2003) investigated the manufacturer’s optimal encroachment strategy considering consumer channel preferences and found that the manufacturer’s encroachment can benefit a retailer when the consumers’ preferences for the manufacturer’s direct channel are medium. Arya et al. (2007) investigated the effect of the manufacturer’s cost of selling directly to consumers (i.e.,

Model fundamentals

We consider one exclusive retailer who sells products from an upstream manufacturer, and the manufacturer can also sell its products in its own direct channel, if it wishes. In the model extension (see Section 6.1), we relax the exclusive retailer assumption and consider that the manufacturer sells through a nonexclusive retailer who also sells a substitutable product from a different manufacturer. Besides, we assume that the manufacturer always sells through the retailer’s traditional channel

Model analysis

We first analyze the centralized supply chain and decentralized supply with no encroachment in Section 4.1. Then, the no equal pricing setting and equal pricing setting are analyzed in the two subsequent subsections (Sections 4.2 No equal pricing setting, 4.3 The equal pricing setting).

Comparative analysis

We first compare the no equal pricing and equal pricing settings when the manufacturer encroaches in Section 5.1, After that, we compare the equilibrium results under no encroachment and encroachment (without equal pricing and with equal pricing) to obtain the manufacturer’s equilibrium decision when the manufacturer can convey a credible commitment of equal pricing in Section 5.2. Then, we investigate the impact of equal pricing commitment by comparing the results in the two cases where the

Model extensions

In this section, we consider three model extensions: (1) a nonexclusive retailer: the retailer sells a partial substitute from a different manufacturer; (2) a sole channel of direct selling: the manufacturer has an option of selling products only through the direct channel; and (3) different pricing sequences.

Concluding remarks

In this paper, we consider the interplay between the manufacturer encroachment (i.e., the manufacturer introduces a direct channel to compete with a retailer’s traditional channel) and the equal pricing strategy (i.e., the manufacturer commits to setting the retail price in its direct channel to equal the retail price in the retailer’s channel). We build a game-theoretic model to analyze this problem. The manufacturer first determines whether to encroach on the market and then decides whether

CRediT authorship contribution statement

Shengming Zheng: Conceptualization, Data curation, Formal analysis, Investigation, Methodology, Software, Validation, Visualization, Writing - original draft, Writing - review & editing. Yugang Yu: Funding acquisition, Project administration, Resources, Supervision.

Acknowledgments

The authors thank the editors and anonymous referees for their comments that have helped improve the paper. This work was supported by the National Key R&D Program of China (Grant No. 2020AAA0103804), the National Natural Science Foundation of China (Grant No. 72091215/72091210, 71921001, and 71991464/71991460), the USTC Research Funds of the Double First-Class Initiative (YD2040002004), and the National Social Science Foundation of China (Grant No. 17CGL057).

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