The impact of retail pricing leadership under manufacturer encroachment

Abstract

We examine how retail pricing leadership affects a manufacturer's encroachment decision and how manufacturer encroachment affects its retailer's profitability. When a manufacturer encroaches on the retail market by introducing a direct channel, both the manufacturer and its existing retailer need to set retail prices for their own channels. In setting the retail prices, either the manufacturer or the retailer may be the first mover, or the two may set prices simultaneously. We show that retail pricing leadership significantly affects the encroachment decision if the manufacturer has a selling cost disadvantage in the direct channel. If the manufacturer can lead by setting its direct channel selling price first, it is more likely to encroach, and will do so as long as the degree of consumer acceptance of the direct channel is larger than 1/2. Otherwise, the manufacturer is equally likely to encroach if the retailer sets the retail price first or if they set the prices simultaneously, and the encroachment decision depends on the degree of consumer acceptance of the direct channel and the direct selling cost. Interestingly, when the manufacturer sets its direct selling price before or simultaneously with the retailer, it launches the direct channel to create a threat to the retailer, while when the retailer has first-mover advantage, the manufacturer may directly sell to consumers.