Selling through outlets: The impact of quality, product development risk, and market awareness

Abstract

We consider a monopolist manufacturer of a luxury good who currently sells a product through a retail store. The manufacturer must decide whether to also offer this product, at a lower quality level, through a factory outlet store. We study how this decision depends on the relative qualities of the products offered on the two channels, as well as the manufacturer's ability to develop successful new products. Our multi-period model captures both risky new product development and the impact of outlet sales on the manufacturer's brand awareness. We find that the manufacturer's optimal strategy will be one of three options: expand into the existing outlet channel by introducing a low-quality version of the product, do not expand into the outlet channel, or expand into the outlet channel only when new product development is successful. The “wait and see” strategy becomes optimal when the fixed cost associated with expanding into the outlet channel is moderate and the likelihood of successful new product development is low. In this case, expanding into the outlet channel is only preferred when new product development is successful because successful development helps counteract the negative impact of outlet sales on the perceived exclusivity of the brand. Finally, we demonstrate that the manufacturer's optimal strategy is dependent on the level of product differentiation provided by the outlet and the impact of brand awareness on brand quality.