Competition in Dual Markets: Two Game-Theoretical Models on Pricing in Online versus Multiple Channels

Abstract

This paper develops two theoretical models to explain why multichannel retailers (MCRs) usually price higher than pure Internet retailers (DotComs), a regular pattern observed in many empirical studies. In the first game-theoretical model, we assume that the number of non-MCRs in the conventional market is exogenously determined, while consumers are classified into three discrete groups: (a) aggressive consumers, (b) discreet online consumers, and (c) offline consumers. We relax the first constraint in the second model so that all retailers in the Brick & Mortar sector are potential MCRs. Before setting prices, these retailers have to make their entry choices. Then, the pricing distribution becomes related to the factors such as the number of retailers in two markets, the search costs, and the pricing strategies of the retailers in the online market. We explore how the different types of retailers compete in the dual channels. We find that MCRs benet from the existence of their conventional stores, since they can charge higher prices than marginal production cost and earn positive profits. However, if DotComs cannot differentiate themselves by building loyal consumers or investing in the new technology, they face the severe competition both from their own type and from MCRs, and gain zero profits. The price dispersion may exist in the long term due to the pricing strategy for MCRs to conciliate the competition in online market.