Optimal channel structure for vertically differentiated products

Manufacturer encroachment becomes increasingly more prevalent and incurs channel competition and product competition. This paper investigates an effective encroachment format (i.e., direct selling or agent selling) to ease channel competition, and analyzes how providing vertically differentiated products (i.e., easing product competition) affects the effectiveness of easing channel competition in improving the manufacturer’s profit. Our analysis shows that the double marginalization effect of the direct channel caused by agent selling may produce a positive effect, easing channel competition. On this basis, we find that adopting quality differentiation can generate a synergy (mitigation) effect to strengthen (reduce) the effectiveness (ineffectiveness) of easing channel competition in improving the manufacturer’s profit. In addition, adopting quality differentiation enhances (reduces) the manufacturer’s preference for direct selling (non-encroachment). Further, we explore the strategic interplay between partners. We uncover that encroachment always hurts the retailer, while the retailer can prevent encroachment under quality differentiation strategy (i.e., an anti-encroachment behavior). Furthermore, although anti-encroachment causes strategy conflict between partners, Pareto improvement can achieve consistency. Interestingly, the selfish behavior of the manufacturer or retailer that pursues solely maximizing individual profit leads to an encroachment trap or an anti-encroachment trap, that is, a non-optimal result occurs. Remarkably, although anti-encroachment may be ineffective, can generate an anti-encroachment potential or an anti-encroachment threat to reduce the loss of encroachment. In particular, the manufacturer’s countermeasures (i.e., changing the equilibrium encroachment strategy) may form a deterrence to force the retailer to abandon anti-encroachment.