Strategic introduction of the marketplace channel under spillovers from online to offline sales

Hightlights

1. We explore whether the marketplace channel should be introduced in online retailing.

2. We study different spillover effects of online to offline sales on channel struture.

3. We also consider the platform fee and the third-parity retailing inefficiency.

4. We investigate the co-opetition between the upstream manufacturer and the e-tailer.

5. We present the condition under which both parties benefit from the introduction.

Abstract

In recent years, the increasing prevalence of online retailing has given rise to a novel e-channel—the marketplace—in which manufacturers sell their products directly to consumers by paying fees to e-tailers. This e-channel, unlike the conventional reseller e-channel, endows manufacturers with absolute control over prices, which helps protect brick-and-mortar channels, especially in the presence of different types of spillovers from online to offline sales. However, the marketplace channel is nevertheless not used in practice in some instances as a result of the e-tailer’s costly platform fees and the manufacturer’s inefficiency in direct retail sales. These different attitudes raise key questions of whether and under what conditions the marketplace channel should be introduced in addition to the reseller channel. In this paper, we study these problems by measuring the combined effects of the online spillover, the platform fee and the manufacturer’s retailing inefficiency. We demonstrate that the manufacturer’s willingness to employ the marketplace channel increases and the e-tailer’s willingness to do so decreases in the level of spillovers; when combining the two, we find that a Pareto improvement can be achieved under a moderate spillover. We also present an interesting insight that the introduction of the marketplace channel fundamentally changes the effects of the spillover on the e-tailer while merely strengthening those on the manufacturer. Moreover, a higher platform fee does not necessarily incentivize the e-tailer to join the marketplace, and the manufacturer’s retailing inefficiency may either benefit or harm the e-tailer, depending on the size of the platform fee.

Introduction

Online retailing has experienced strong growth in the past decade. For instance, in the U.S., online retail sales reached $290 billion in 2013, accounting for 9% of total U.S. retail sales (Sehgal, 2014). In China, the country with the largest scale and highest rate of e-channel development, online retail sales reached 3.2 trillion RMB and accounted for 11% of total retail sales in 2015 (Sun, 2016). With the increasing prevalence of online retailing, a novel e-channel—the marketplace—has emerged, in which an upstream manufacturer is able to engage in direct selling while paying a platform fee to an e-tailer to access online customers. This channel has been widely embraced, for example, by Amazon (through Amazon Marketplace), Sears (through the Marketplace at Sears), Taobao in China (Bonfils, 2012), and Flipkart in India (Tiwari, 2014). For Amazon, the largest online retailer, transactions through the marketplace channel accounted for approximately 40% of sales in 2012 (Barr, 2012), up from 30% in 2009 (Stone, 2009). Amazon has contended that the novel marketplace and conventional resellers can complement one another; for instance, in the context of book sales, the introduction of the marketplace channel offers a “service to readers that allows them to explore new authors and areas of interest.” Thus, both Amazon and publishers can benefit from this practice in the long run (Mantin, Krishnan, & Dhar, 2014).

Nevertheless, some manufacturers and e-tailers have refused to adopt the novel marketplace. For instance, in some mature digital industries, this new channel has yet to be introduced, and the conventional reseller continues to prevail as the dominant channel. For example, most artists and record labels still sign reseller agreements with online music stores, e.g., iTunes, Spotify, and AliMusic. The marketplace channel is also frequently rejected by e-tailers in other industries, such as by Everlane, an American fashion e-tailer, VANCL, the fourth-largest online apparel e-tailer in China, and JMEI, the number one cosmetics platform in China.

These different attitudes have sparked interest in understanding the economics of the marketplace channel. Generally, a major characteristic of the marketplace channel is to endow manufacturers with absolute control over retail prices (Abhishek, Jerath, & Zhang, 2015), which plays a critical role in protecting the brick-and-mortar channel in multichannel retailing, especially in the presence of spillovers between online and offline sales (Wogahn, 2013). As the executive of American eyeglass e-tailer Warby Parker contended, “The future of retail sits at the intersection of e-commerce and brick and mortar” (Shearman, 2016). The cross-channel spillover is fairly common and essential in practice and, further, its directions often differ. For instance, in some industries, such as apparel and computers, online sales can negatively affect offline demand (Brynjolfsson, Hu, Rahman, 2009, Goolsbee, 2001). Conversely, in media industries, such as movies and music, e-channel sales strongly stimulate sales in the traditional channel because these e-channel sales attract new customers (Mortimer, Nosko, Sorensen, 2012, Smith, Telang, 2010). In other cases, such as for books, the spillover effect of online sales on offline sales is positive but small (Hilton & Wiley, 2010). This variety in the effects of the spillover makes a manufacturers’ decision of whether to introduce the marketplace channel more difficult, as that decision will change sales levels in the e-channel, which will, in turn, impact sales in the brick-and-mortar channel and, ultimately, the aggregate profit.

Moreover, with respect to the introduction of the marketplace, manufacturers and e-tailers also cannot ignore other characteristics of this novel e-channel, such as the platform fee, which allocates profits between two parties, and the manufacturers’ sales disadvantage relative to the e-tailers. In practice, it is common for (incumbent) e-tailers to provide the consumer with a more satisfactory experience in the sales process, which is akin to manufacturers’ skill in production. The e-tailers’ advantage in retailing may stem from better product quality and return services, from more direct contact with customers and superior knowledge of customer preferences or from economies of scope with other retailing activities. For instance, Amazon’s safe return policies and guarantees have become one of its largest advantages in attracting consumers.

These combined effects of the online spillover, the platform fee, and the manufacturers’ sales inefficiency, make it more complicated to predict the manufacturer and e-tailer’s attitudes toward the introduction of the marketplace channel, thus giving rise to interesting questions that are worthy of exploration. First, how will the manufacturer and the e-tailer respond to the introduction of the marketplace channel? Whether and under what conditions can they reach an agreement? Second, what impacts will the different types of spillover (the stimulation spillover and the cannibalization spillover) have on the manufacturer and e-tailer? Will the impacts remain constant with the introduction of the marketplace channel? Third, how will the platform fee and the manufacturers’ retailing inefficiency affect the preferences of the manufacturer and e-tailer? Will the e-tailer always benefit from a higher platform fee and greater retailing inefficiency on the part of his rival manufacturer?

To capture the aforementioned issues, we develop a model in which a manufacturer (she) cooperates with an e-tailer (he) to sell her products to online consumers through two e-channels—the reseller and the marketplace. The manufacturer also sells her products through a brick-and-mortar channel, which is either positively or negatively affected by the online sales volume. Under this framework, we explore the manufacturer and e-tailer’s payoffs with and without the introduction of the marketplace channel. Further, to emphasize the effect of spillovers, we study these questions in the absence and presence of spillovers. After deriving the equilibrium solutions of these cases, we obtain the equilibrium strategies and gain some novel management insights.

First, we find that the manufacturer’s willingness to adopt the marketplace increases with the level of the spillover, while the e-tailer’s willingness to adopt it declines with the level of the spillover; thus, they can achieve a Pareto improvement by introducing the marketplace channel with a moderate spillover. This is because the double marginalization in the reseller channel will hinder the manufacturer from adjusting online output to maintain offline sales, which directly incentivizes her to introduce the marketplace channel that endows her with absolute control over prices. Moreover, a moderate spillover, i.e., not too high or too low, does not provide the manufacturer with a strong incentive to greatly increase or decrease online output from the perspective of maximizing total profit. Thus, the online sales volume will not be greatly distorted, which guarantees the e-tailer’s participation in the marketplace channel.

Second, we find that, regardless of whether the marketplace channel is introduced, the cannibalization spillover always harms the manufacturer, while the stimulation spillover always benefits her; the introduction of the marketplace merely strengthens the effects of spillovers on the manufacturer. Counterintuitively, while the cannibalization spillover always harms the e-tailer, the stimulation spillover has different impacts on him with and without the marketplace channel. When the marketplace channel is not introduced, the stimulation spillover always benefits the e-tailer because the only method that a manufacturer can use to increase online output to stimulate offline sales is to decrease her wholesale price, thereby reducing the e-tailer’s acquisition cost. However, once the marketplace channel is introduced, the manufacturer can directly reduce the retail price in the marketplace channel, which considerably harms the e-tailer owing to not only the loss of the lower acquisition cost but also the competitive pressure from the rival’s price reduction.

Third, whereas a higher platform fee always diminishes the manufacturer’s motivation to introduce the marketplace channel, this does not necessarily incentivize the e-tailer to introduce the marketplace channel. This is because, given a sufficiently high platform fee, nearly all of the profit from retailing is captured by the e-tailer, which is similar to the situation without the marketplace channel. However, in this case, the e-tailer suffers from competition between the two e-channels and from sales inefficiency in the marketplace channel. Thus, he prefers to reject the marketplace channel. Moreover, we find that the manufacturer’s retailing inefficiency always harms the manufacturer and may also harm the e-tailer, depending on the platform fee. With a sufficiently high platform fee, the marketplace channel not only acts as a competitor of the reseller channel but also becomes a considerable profit source for the e-tailer. Thus, he will also be harmed by this retailing inefficiency.

The remainder of this paper is organized as follows. In Section 2, we briefly review the related literature. In Section 3, we set up the model. In Section 4, we study the manufacturer and e-tailer’s equilibrium strategies with respect to introducing marketplace in the absence of spillovers. In Section 5, we further investigate the two parties’ equilibrium strategies in the presence of spillovers. In Section 6, we emphasize the impacts of spillovers on the manufacturer and e-tailer with and without the introduction of the marketplace. In Section 7, we extend our results by altering the assumptions of the model. In Section 8, we conclude the paper with a brief discussion.