Merchant and Platform: Pricing Strategy and Product Entry

Abstract

Managing merchants challenges a selling platform. Using a multi-sender framework we ask if a platform and a competing merchant’s prices can together signal product quality if consumers’ information is incomplete. We find that both separating and pooling equilibria exist but for separation what is critical is that there are two senders with the merchant playing a key role. On the other hand, a single firm’s prices do not signal quality, thus highlighting multi-sender signaling. A practical question we ask: can the platform use a limited assortment strategy to profitably eliminate the need for price signaling? We use our signaling results to compare the profits of signaling to the limited assortment strategy that has multi-period implications. The assortment strategy is indeed profitable under conditions we identify. We then prove the existence of such a profitable strategy constructively. We find the strategy to be especially profitable when the incidence of a low quality product occurs with small probability, and with a significantly lower quality. We also display casual observation of the effect of Amazon entry on prices and sales with a few examples that is in accord with our theoretical results.