Assessing the Consequences of a Channel Switch

Abstract

Switching marketing channels is an expensive and sticky decision. While a number of theories suggest efficiency and strategic differences between channels, there is virtually no work on combining these ideas into an empirically workable methodology to assess the impact of a channel switch. In this study, we undertake to close this gap with an empirical study of the sports drink market, featuring competing producers and heterogeneous channels. We estimate demand and cost parameters for a number of alternative models of competitive interaction and use these estimates to study the switching of Gatorade from its extant (independent wholesaler) channel to the direct store delivery (DSD) channel belonging to Pepsi. Our initial results indicate the following: Pepsi should switch Gatorade to the DSD channel only if (i) the switch decreases Gatorade's manufacturing cost by at least 14%, or (ii) the switch increases the share of profit it can obtain by at least 13%, or (iii) the switch enhances demand by the equivalent of a price cut of 4.96¢ for a 32-ounces package. Absent these increases, Pepsi should not switch. Our methodology and results speak to both managers contemplating a channel switch and antitrust authorities faced with the task of evaluating the consequences of a change in vertical structure.