Retailer Dominance and Quality Variation: Observations and a Theoretical Explanation

Abstract

A number of consumer and business reports suggest that slightly lower quality (or feature) versions of products are being sold through dominant retailers, while higher quality versions continue to be sold through weaker retailers and, customers are uninformed about such subtle differences. We study two intriguing questions based on this phenomenon namely (1.) why are lower quality-lower priced versions sold primarily through dominant retailers and not the weaker retailers? (2.) Why do sometimes the weaker retailers not inform customers about these quality differences? Using a game theoretic model, we find that when quality is noncontractible an increase in retail dominance leads to a decrease in quality offered by the dominant retailer vis-à-vis the weaker retailer. However, we show that the weaker retailer does not have an incentive to advertise its higher quality if quality differences are not too high. This situation arises endogenously when the dominant retailer is not too powerful as compared to the weaker retailer or when retail differentiation is high. The motivation for this result is traced to the threat of increased competition in the event of such advertising.