Retail Competition on Salop Circle under Linear Demand: Implications for Distribution Strategy

Abstract

Existing applications of the Salop model (1979) to oligopolistic competition between retailers assume that demand is constant or has constant elasticity. With these formulations, demand is never zero, retailers always compete, and transport costs, as barriers to competition, always raise equilibrium profits. In contrast, we introduce linear demand to the Salop model to develop a framework that includes spatial monopolies and perfect competition as special cases. This model generates a price ceiling above which demand is zero, and the effect of transport cost is no longer unidirectional. An increase in transport cost, as detrimental to demand generation, reduces profits when the price ceiling is low and, as barrier to competition, raises profits when the price ceiling is high. We show that a monopolist manufacturer can use retailer competition to keep retailer margins low and reduce double marginalization, achieve approximate channel coordination, and usurp most of the profit gains from the coordination. Introduction of an online retailer to our model reduces retailer margins further, expands demand, and allows a manufacturer to distribute through fewer retailers.