Selling vertically differentiated products under one channel or two? A quality segmentation model for differentiated distribution channels

Abstract

Many manufacturers have adopted differentiated distribution channels to market vertically differentiated products. However, there is scant literature addressing the quality differentiation in the presence of differentiated channel policies. We, therefore, examine whether (how) differentiated channel policies affect manufacturers’ quality differentiation and all parties’ performance. Specifically, we consider a manufacturer who produces high- and low products together, but with two marketing options: (1) distributing both products through one retailer (Model O), or (2) providing high quality products through one channel but low-tier products through another (Model T). Our results show that the manufacturer is more likely to decrease the level of quality differentiation in Model T than in Model O. Moreover, we show that “quality distortion” is not limited to low-tier products but can occur with high-tier products. We also comment on how the additional horizontal consumer heterogeneity affects our results and the implications of the competition at the manufacturer level.

Keywords:

• Manufacturing/marketing interface
• quality segmentation
• channel policy
• game theory

Acknowledgements

The authors would like to thank the anonymous referees for their valuable comments.

Disclosure statement

The authors declare no conflict of interest.

Notes

1 Throughout this article, we use the feminine pronoun to refer to the manufacturer and the masculine pronoun to refer to the retailer.

2 We thank an anonymous reviewer for pointing this out.

3 See Appendix for the detailed derivation. We thank an anonymous reviewer for suggesting to list the detailed derivation.

4 For clarity, all proofs are provided in the appendix.

5 This determination differs from those of Chung and Lee (2014), which is a key difference that we believe stems from our model’s focus on different channel policies and competition between retailers rather than a channel composed of one manufacturer and one retailer, which is either vertically integrated or decentralised.

6 All channel members independently seek to maximize their own profit, resulting in higher retail prices and lower sales quantities and profits than in a vertically integrated channel (Spengler, 1950).

7 We thank an anonymous reviewer for suggesting these two possible model extensions.

8 We refer interested readers to Seifbarghy et al. (2015) for a complete discussion.

9 Zhang and Cao (2014), for example, show that when product quality is not readily observable to all consumers, a one-roof policy facilitates more efficient signalling and results in greater profit than a two-roof policy.

10 To enable clear analysis of the effect of transaction cost, we assume that the retailer’s unit marketing costs for high- and low-tier products are identical, i.e., $c_h=c_l=c,$ and normalised to zero, i.e., $c=0.$

Additional information

Funding

This research is partially supported by the National Natural Science Foundation of China (71531003, 71872028), the Humanities and Social Sciences Foundation for Young Scholars of China’s Ministry of Education (15YJC630154) and Research Fund for the Circular Economy (XHJJ-1805).