The Impact of Free Riding on Price and Service Competition in the Presence of E-Commerce Retailers

Abstract

An extensive literature has focused on price competition and the Internet; however, little attention has been given to the Internet's impact on service competition. Services include activities such as the provision of product information, repairs, faster checkout, after-sales advice/information, retail advertising, certification of products by limiting the available assortment size, and the ability to examine/test merchandise. A consumer rides when the customer uses services at one retailer (e.g., test drives a car or examines clothing), but purchases the merchandise at another retailer (for example, an online store). This paper examines the impact of free riding and E-commerce on the provision of retail services by focusing on two types of consumer heterogeneity. Consumers are heterogeneous with regard to: location (horizontal differentiation), and their preferences for purchasing online vs. offline. All shoppers are assumed to have access to E-commerce retailers, but one group of shoppers is assumed to be Internet (E-commerce) prone, while the other group has a preference for Brick and Mortar (Retail) stores. Intuitively, we expect that consumer free riding harms retailers who provide services. In a sense, consumer free riding is analogous to a theft of services. The free riding consumer uses one retailer's resources, but all the revenues accrue to the retailer that makes the actual sale. As a consequence, it is difficult to see how the retailer providing services could benefit from consumer free riding. Nonetheless, we find that, under certain circumstances, the retailer providing services does benefit from consumer free riding. The intuition is that consumer free riding softens service competition between the conventional retailer (who provides the services) and the E-commerce retailer (who sometimes makes the sale). We also consider the case of the coordinated channel (i.e., where both the Internet and non-Internet retailers are controlled by a single entity seeking to maximize channel profits). The channel coordinator must decide when it is profitable to distribute its products online and at what price/service proposition. The conventional wisdom is that, in a coordinated channel, the channel coordinator will discourage E-commerce from the fear that consumer free riding will undercut conventional retailers' incentives to provide services, thereby lowering channel profits. Instead, we find that the propensity of channel coordinators to use E-commerce distribution channels is increasing with the consumer's free riding. The intuition for this result is that we allow channel coordinators to set the level of retail services independently of the retailer’s product delivery function. Hence, channel coordinators may find it desirable to deliver services using conventional retail, but make product sales online. Finally, we consider the case of two competing manufacturers. Conventionally, when two manufacturers compete to provide an undifferentiated product, with undifferentiated services, profits decline in the consumer's preference for services. We find, however, that in the presence of an E-commerce channel (and provided that the Internet prone segment is large enough), the two manufacturers' profits can increase in the consumer's preference for services, even when the products and services are undifferentiated.