Channel strategy for manufacturers in the presence of service freeriders

We examine the case of a manufacturer that must decide whether to sell its product directly to the customer through its own store, and/or indirectly through an independent retailer; both the manufacturer and the retailer must decide on the level of service effort they will provide to the customer. When customers are dissatisfied with a product, they will make an extra trip to return that product. Pre-sales service improves customers’ satisfaction with the product and reduces customer returns, but providing that service may be costly for the seller, and not all service leads to immediate sales. In particular, when a channel provides a high level of service, some customers may first visit this channel's store to take advantage of the service, only to buy the product from a cheaper channel (freeriding). This paper examines the impact of customers’ freeriding behavior on a manufacturer's channel strategy. We find that the cost bearer of freeriding (the firm on which the customers freeride) can be better off, and the beneficiary of freeriding (the firm from which the freeriding customers purchase the product) can be worse off, when customers can freeride. We also find that when customers can freeride, the manufacturer is less likely to use the dual-channel structure, and total demand may be smaller, even though customers have the flexibility of choosing where to buy after experiencing pre-sales service.