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Int. J. Production Economics: Moutaz Khouja, Sungjune Park, Gangshu (George) Cai
Int. J. Production Economics: Moutaz Khouja, Sungjune Park, Gangshu (George) Cai
a r t i c l e in f o a b s t r a c t
Article history: We analyze channel selection and price setting of a manufacturer who has several distribution options
Received 23 March 2009 which include selling through (1) a direct channel, (2) a manufacturer-owned retail channel, and/or (3)
Accepted 9 January 2010 an independent retail channel. The manufacturer can use any combination of these options. We divide
Available online 18 January 2010
consumers into two segments: (1) a retail-captive segment whose consumers do not use the direct
Keywords: channel and (2) a hybrid segment whose consumers may use either channel. Hybrid segment
Pricing consumers are heterogeneous in their channel preference. We identify the relative segment sizes and
Multi-channel distribution consumers’ channel preferences under which different distribution strategies are optimal. Our analysis
E-commerce indicates that the most critical factor in channel selection in a vertically integrated supply chain is the
Vertically integrated supply chains
variable cost per unit of product sold using the direct vs. the retail channels. In the presence of
independent retailer, the size of the retail-captive consumer segment relative to the size of the hybrid
consumer segment becomes a major factor in channel selection.
& 2010 Elsevier B.V. All rights reserved.
0925-5273/$ - see front matter & 2010 Elsevier B.V. All rights reserved.
doi:10.1016/j.ijpe.2010.01.005
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M. Khouja et al. / Int. J. Production Economics 125 (2010) 84–95 85
Chiang et al. (2003) developed a model of a manufacturer who To alleviate potential channel conflict when both the retail and
can sell directly on the Internet, exclusively through a retailer, or a direct channels are open, Mukhopadhyay et al. (2008a, 2008b)
combination of the two. The supply chain can be vertically suggested that allowing the retailer to add value to the product
integrated or the retailer can be independent. The manufacturer may result in product differentiation to consumers and hence
sets the Internet price and the wholesale price and the retailer increase the manufacturer and retailer’s profit. The second model
sets consumers’ price as a Stackelberg follower. Consumers’ (Mukhopadhyay et al., 2008b) focuses on hi-tech industries. The
reservation prices are uniformly distributed on [0,1] for the retail authors further investigated the impact of the retailer adding value
channel and on [0, y], where y o1, for the direct channel. The when the manufacturer has complete vs. incomplete information
restriction on y reflects the assumption that retail provides a regarding the retailer’s cost of adding value, and quantified the value
superior shopping experience. A main finding of the model is that of information to the manufacturer. They found that the manufac-
the direct channel enables the manufacturer to reduce double turer benefits from more information and the retailer would be
marginalization associated with the retail channel. The increased willing to share information with the manufacturer if her cost of
leverage provided by the direct channel is inversely related to the adding value is lower than a threshold value.
parameter y. Also, the direct channel may not always harm the Kumar and Ruan (2006) developed a model of a manufacturer
retailer because, in certain cases, a reduction in the wholesale using retail and direct channels. Consumers can be brand-loyal or
price accompanies the use of a direct channel. retailer-loyal. The retailer carries the manufacturer’s brand and
Chiang and Monahan (2005) developed a two-echelon dual others. Brand-loyal customers buy only the manufacturer’s
channel inventory model in which inventory is kept at a product. The direct channel attracts brand-loyal consumers who
warehouse and at retailer locations. Warehouse inventory is used are price insensitive. The retailer maximizes product category
to satisfy direct channel sales. Some consumers prefer retail stores profits rather than just the profits from the manufacturer’s
and others prefer the direct channel. In case of a shortage in the product. To do so, the retailer must decide on the sales support
warehouse, a proportion of consumers switch to the retail channel level for the manufacturer’s product. The authors find that when
and vice versa. The authors use inventory-related operational consumers’ price-sensitivity difference between the two channels
costs to evaluate the performance of the system and to compare exceeds a certain threshold, the manufacturer is better off
retail-only distribution, direct only distribution, and dual channel without a direct channel. Wang and Webster (2007) analyzed a
distribution. The main finding indicates that dual channel strategy supply chain of a single manufacturer selling a perishable product
outperforms single-channel strategies in most cases. to a single retailer facing uncertain demand. The manufacturer is
Cattani et al. (2006) developed a model in which a manufac- risk neutral and the retailer is loss averse, which decreases the
turer with an independent retail channel opens a direct Internet retailer order quantity and total supply chain profit. The authors
channel. The manufacturer determines the wholesale price as the investigate the role of a gain/loss sharing provision for mitigating
Stackelberg leader and sets the direct price equal to the retailer’s the loss-aversion effect.
price. The model analyzes three strategies: (1) the manufacturer Our model is related to the models of Cattani et al. (2006) and
keeps the wholesale price charged prior to opening the direct Chiang et al. (2003). However, we explicitly consider the existence
channel, (2) the manufacturer’s policy results in the retail price of the retail-captive consumer segment (Koufaris and Hampton-
remaining unchanged, and (3) the manufacturer sets the whole- Sosa, 2004). Consumers in this segment do not use the direct
sale and direct channel prices to the values which optimize its channel for one or more reasons which may include: loyalty to the
profit. Consumers are assumed to be heterogeneous in terms retailer (Kumar and Ruan, 2006), lack of access, privacy and
of channel preference. Individual consumers’ utility function is security concerns, inability to touch and feel the product (Ahuja
decreasing in price and in purchase effort. Channel preference is et al., 2003), difficulty in returning products (Nitse et al., 2004), or
captured by the purchase effort which is assumed to be uniformly fear of financial theft (Swinyard and Smith, 2003). Moreover, we
distributed on ½0; Ef fi , where i is a channel index. Findings explore a wider range of marketing alternatives which received
indicate that Strategy 3 is optimal and is often also preferred by little or no attention in the literature. Specifically, we analyze the
the retailer and consumers because of lower prices. channel selection for a vertically integrated supply chain where
Fruchter and Tapiero (2005) considered a manufacturer who the manufacturer who, in addition to selling through manufac-
sells a product through retail stores and an online virtual store. turer-owned stores, can also sell directly using the Internet. Our
Similar to Chiang et al. (2003); Fruchter and Tapiero (2005) assume model also differs from Chiang et al. (2003) in that we assume
that consumers have less valuation for a product purchased online. that consumers may prefer either the direct channel or the retail
The authors conclude that the manufacturer’s optimal strategy is to channel, whereas they assume consumers always prefer the retail
charge the same price across both channels. channel.
Rhee and Park (2000) developed a model in which a manufac- The distribution strategies available to manufacturers can be
turer operates an online store, uses an independent retailer, or uses divided as follows:
both options. The retailer provides services that the online store I. Marketing strategies without an independent retailer. In such
cannot. Consumers are assumed to have uniformly distributed cases, the manufacturer does not use an independent retailer and
reservation prices. A fixed proportion of consumers are sensitive to may select one of the following options:
the retailer’s service. The authors show that a hybrid system is
preferable when consumers’ valuations of the retail service are
similar across segments. I.a. An exclusive manufacturer-owned retail channel. The product
Tsay and Agrawal (2004a) also considered retail and direct can be obtained only through manufacturer-owned retail
channels. Demand in each channel is a linear function of the outlets. Examples include chemical firms selling gasoline and
retailer’s and manufacturer’s efforts. If the manufacturer uses paint such as Devoes and Durons.
both channels, the demand in each channel is a proportion of the I.b. An exclusive direct Internet channel. The product can be
total demand in both channels. The authors suggest that the obtained only through the direct channel. Examples include
preference for a channel alternative depends on supply chain Dell computers.
efficiency and marketing capability. However, both the manufac- I.c. Direct channel and manufacturer-owned retail channel. The
turer and retailer can benefit from a dual channel if the product can be obtained through either channel. Examples of
manufacturer is willing to reduce the wholesale price. this strategy are becoming more popular with manufacturers
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86 M. Khouja et al. / Int. J. Production Economics 125 (2010) 84–95
since the emergence of the Internet. Bose Corporation, for and retail channels. Some consumers prefer the retail channel
example, operates factory stores for retail-captive consumers over the direct channel with varying strength and the opposite is
but also sells directly on the Internet. Other examples include true for other consumers. The following notation is used:
Banana Republic and J Crew. Possible reasons for not offering
i= r or d where r denotes retail channel and d denotes direct
the product through an independent retailer is to have
Internet channel,
complete control over pricing and the image of the product.
ci = the cost per unit of product sold using channel i,
Di =product demand via channel i,
II. Marketing strategies with independent retailer(s). In this case,
Pi = price per unit of the product sold using channel i
the manufacturer can choose:
al =size of consumer segment l, which can be hybrid or retail-
captive,
II.a. An exclusive independent retailer(s) channel. Many consumer
xj = preference strength for the retail channel over the direct
products are sold using this strategy.
channel of consumer j in $,
II.b. An exclusive independent retailer(s) channel and a direct channel.
f ðÞ = the probability density function of xj , a uniform
Since the emergence of the Internet many manufacturers have
distribution on ½a; b, 1 oa o0 and 0 ob o1,
opened up a direct channel, in addition to the existing
independent retail channel. Examples include Sony BMG music. FðÞ= the cumulative distribution function of xj ,
T= index of business entity, R is for retailer, M is for
manufacturer, and S is for the supply chain,
This is partial enumeration of strategies. Some manufacturers,
K =index of industry structure, V is for vertically integrated,
such as Hanes, offer their products through their own direct
and I is for independent retailer,
channel, manufacturer-owned retail stores, independent brick
L= index of distribution strategy, ER is exclusive retail, ED is
and mortar retailers, and online retailers.
exclusive direct, and DL is dual, and
The remainder of this paper is organized as follows. In Section 3,
we analyze the strategies in category I. Table 1 shows the PðK;LÞ
T = profit of entity T under industry structure K and
optimal prices and profits for strategies I.a and I.b. Table 2 shows distribution strategy L.
the possible optimal solutions for strategy I.c. We discuss channel
conflict resulting from strategies in category II and optimal We assume that consumers are heterogeneous in their
channel selection in Section 4 and present some numerical valuation of the product. Let r be the consumption value
examples. We provide a summary of results, a discussion, and (reservation prices) which, similar to the assumption in Chiang
conclusions in Section 5. et al. (2003), is assumed to be uniformly distributed between 0
and 1 to maintain analytical simplicity. Therefore, in a market
with a density of 1, if price is P, then demand is given by ð1PÞ and
3. Marketing options without an independent retailer in a market of size a consumer demand is given by að1PÞ. We
also assume that this consumer demand is valid when the product
One segment of consumers does not use the direct Internet is offered on the consumers preferred channel. This implies that
channel at any price, making its consumers retail-captive. Other there is no additional utility gained when a consumer purchases
consumers belong to a hybrid segment and may purchase from the product on their preferred channel. If the product is offered on
the direct or the retail channels. We assume that hybrid the consumers’ non-preferred channel, then consumers impose a
consumers are heterogeneous in their preferences for the direct penalty on the product in this non-preferred channel. The results
in this paper are predicated on the resulting demand function, and
Table 1 may not be true for other demand functions.
Optimal distribution strategy without an independent retailer. Channel preference of hybrid consumer j is measured by xj . If
xj 4 0 then hybrid consumer j prefers the retail channel, if xj o0
Strategy Optimal prices Optimal profit
then consumer j prefers the direct channel, and if xj ¼ 0 then
Exclusive 1
a3 a
½a3 ah þ 2R2 að1cr Þ2
consumer j is indifferent. We assume that 1 oa o 0 and
PrðV;ERÞ ¼ 2cr þ 2þ 2 h PðV;ERÞ ¼ 0 ob o 1 which implies that (1) some hybrid consumers prefer
retail 4 R a M
16R4 a
Exclusive 1 b3 ah ½b3 2R2 ð1cr Þ2 the direct channel while others prefer the retail channel and
PdðV;EDÞ ¼ 2cd þ 2 2 PMðV;EDÞ
¼
direct 4 R 16R4 (2) channel preference is less than or equal to the consumption
Dual Depends on condition in Depends on condition in value. Our intention from assuming that xj is uniformly distri-
Table 2 Table 2
buted on ½a; b instead of having a deterministic value of x is to
Table 2
Optimal dual strategy type without an independent retailer.
r - Pr + = 0
3.1. Exclusive retail channel strategy
Pd
Manufacturer
Infeasible
Retail-Focused or Inferior
Pd Dual Strategy
Retailer
1
(Pr-Pd ≤ a)
Pr Pr
Retail Hybrid
Segment Segment Pure Dual
Strategy
1−
R2PDL ¼ fðPr ; Pd Þj0 o Pr o 1; 0 o Pd o1; and a oPr Pd obg; Proposition 1. If cd þ 2b rcr r1 then the direct-focused dual
strategy is globally optimal with unique maximum profit at prices of
R2RFD ¼ fðPr ; Pd ÞjPr 40; Pd 40; and Pr Pd rag;
R2DFD ¼ fðPr ; Pd ÞjPr 4 0; Pd 4 0; and Pr Pd Z bg: ð18Þ PdðV;DFDÞ ¼ 12 ð1 þcd Þ and PrðV;DFDÞ ¼ 12ð1 þcr Þ ð23Þ
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Proposition 3. If cd rcPD rcr rcd þ 2b then the global optimal We begin by illustrating the strategies without an independent
solution is retailer using a numerical example and then discuss the more
difficult strategies with an independent retailer. Consider a
(a) on the boundary of R2DFD with an optimal prices of
manufacturer with the following parameters for demand and
1 cd ðcd þ2bcr Þar consumers’ preference: ar ¼ 0:3; ah ¼ 0:7; a ¼ 0:2; and b ¼ 0:2.
PdðV;DFDÞ ¼ þ and PrðV;DFDÞ ¼ PdðV;DFDÞ þ b
2 2 2a As Table 3 shows, if cr ¼ 0:5 and cd ¼ 0:6; then a retail-focused
ð28Þ dual strategy is the best, followed by an exclusive retail strategy. If
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M. Khouja et al. / Int. J. Production Economics 125 (2010) 84–95 91
Table 3
Optimal marketing strategies under different parameters.
cr cd cPD Condition Strategy(* indicates best) Retail price Direct price Profit
cr ¼ 0:5 and cd ¼ 0:5; then both the retail-focused and pure dual retailer’s profit is given by
strategies are optimal with a profit of 0.0625. If cr ¼
PRðI;ERÞ ¼ ðPr wÞðDr þ Drh1 þ Drh2 Þ ¼ ðPr wÞa½1ðPr þð1yÞðah =aÞx Þ:
0:5 and cd ¼ 0:45; then cPD ¼ 0:557 and cd ocr ocPD . By Proposition
4, a pure dual strategy is optimal with a profit of 0.0682. If ð32Þ
cr ¼ 0:5 and cd ¼ 0:4; then cPD ¼ 0:498 and cPD r cr r cd þ 2b. By Since @ 2
PRðI;ERÞ =@Pr2 ¼ 2a o0, the sufficient condition for
Proposition 3, a direct-focused strategy with direct and retail price optimality of Pr is
difference of b is optimal and the optimal profit is 0.0770. If
PrðI;ERÞ ¼ 12ð1 þwÞDPrðI;ERÞ ð33Þ
cr ¼ 0:5 and cd ¼ 0:05; then cd þ 2b rcr . By Proposition 1, a direct-
focused strategy is optimal with independently determined optimal where DPrðI;ERÞ ¼ DPrðV;ERÞ
shown in (8). Since is DPrðI;ERÞ 4 0, PrðI;ERÞ
prices and an optimal profit of 0.176. This numerical example does lower than the optimal price without the hybrid consumer
not consider the fixed cost of operating a retail or direct channel. As a segment. The resulting optimal retailer profit is
result, the exclusive retail channel strategy and the exclusive direct a
channel strategy are always inferior to dual channel strategies. PRðI;ERÞ ðwÞ ¼ ð1w2DPrðI;ERÞ Þ2 : ð34Þ
4
A Stackelberg equilibrium where the manufacturer is the
4.1. Marketing options with an independent retailer leader is obtained by optimizing the manufacturer’s profit given
the retailer’s optimal pricing. The manufacturer’s profit is
Selling directly to consumers makes a manufacturer a ðI;ERÞ
PM ðPr Þ ¼ 12ðwcr Það1w2DPrðI;ERÞ Þ ð35Þ
competitor to its market intermediaries and gives rise to channel
2 ðI;ERÞ
conflict (Tsay and Agrawal, 2004b). This channel conflict is best Since @ PM ¼ a o0, the sufficient condition for
ðPr Þ=@w2
illustrated by a letter Home Depot sent to more than 1000 optimality of w yields
suppliers (Brooker, 1999) in which they state ‘‘We think it is short- wðI;ERÞ ¼ 12ð1 þ cr ÞDPrðI;ERÞ : ð36Þ
sighted for vendors to ignore the added value that our retail stores
contribute to the sales of their productsy’’. The letter goes on to The resulting optimal manufacturer profit is
state ‘‘However, we too have the right to be selective in regard to the a 1 ðV;ERÞ
vendors we select and we trust that you can understand that a
ðI;ERÞ
PM ¼ ð1cr 2DPrðI;ERÞ Þ2 ¼ P : ð37Þ
8 2
company may be hesitant to do business with its competitors.’’
Substituting for w in (33) with wðI;ERÞ from (36), the retailer’s
Despite the possibility of channel conflict, selling directly to
optimal price in a Stackelberg equilibrium can be written as
consumers using the Internet provides several advantages to
manufacturers including the ability to have closer contact with cr 3 3 1cr DPrðI;ERÞ
PrðI;ERÞ ¼ þ DP ðI;ERÞ ¼ PrðV;ERÞ þ ð38Þ
consumers, direct control over price, protection from crises that 4 4 2 r 4 2
may arise with intermediaries, and ability to offer a broader and the retailer’s optimal profit is
product selection (Tsay and Agrawal, 2004b). Direct selling may
harm the intermediaries whose central role is to build brand and a 1 ðV;ERÞ
PRðI;ERÞ ¼ ð1cr 2DPrðI;ERÞ Þ2 ¼ P : ð39Þ
product awareness by educating consumers, advertising, provid- 16 4 R
ing customer support, collecting market information, etc. If direct From Eqs. (37) and (39), regardless of the value of in a DPrðI;ERÞ ,
selling hampers the ability of the retailer to perform these decentralized supply chain the manufacturer gets half of the
functions and the manufacturer is unable to assume these profit of a vertically integrated firm, and the retailer gets one
functions, the ultimate result may be a loss in market share fourth. Thus, there is a decrease in supply chain profit. This is a
and/or profit. property of ‘‘double marginalization’’ which occurs even if
We study a Stackelberg game in which the manufacturer DPrðI;ERÞ ¼ 0 (implying that there are no consumers who prefer
(leader) sets the wholesale price and the retailer (follower) the direct channel). Consumers also face an increase of
responds by setting its retail price. Stackelberg games are ð1cr Þ=4DPrðI;ERÞ =2 in price over the vertically integrated supply
commonly used in multi-channel studies (e.g., Chiang et al., chain. Since DPrðI;ERÞ =2 ¼ ð1yÞðah =aÞx =4; this price increase
2003; Tsay and Agrawal, 2004a; Yao and Liu, 2005) as well as decreases as the size of the hybrid segment increases and/or
analyzes of non-cooperative supply chains (e.g., Li et al., 2002; Xie their preference for the direct channel increases.
and Ai, 2006). The independent retailer buys the product at a Now suppose the manufacturer opens a direct channel. In this
wholesale price of w and sells it to consumers at price Pr . The case, the retailer serves both retail and hybrid segments while the
ARTICLE IN PRESS
92 M. Khouja et al. / Int. J. Production Economics 125 (2010) 84–95
Unit price, $
1. Sell only through its own retail outlets. Optimal price and profit
are given by Eqs. (7) and (9). A fixed cost of F1 for operating the
retail channel should be subtracted from the profit.
2. Sell only through a direct channel. Optimal price and profit are
given by Eqs. (14) and (16). A fixed cost of F2 for operating the
direct channel should be subtracted from the profit.
Proportion of hybrid consumers, αh 3. Sell through a direct channel and manufacturer-owned retail
outlets. Optimal prices and profit are given by the optimal case in
Fig. 7. Manufacturer, retailer, and supply chain profits vs. ah .
the equations of Table 2. A fixed cost of F1 þ F2 for operating the
direct and retail channels should be subtracted from the profit.
0.57 variable cost per unit for the direct channel is lower than the retail
channel, the retail channel may still be optimal because the direct
0.55 Direct Channel channel cost advantage may be offset by losing the retail-captive
0.53 segment. Similarly, if the variable cost per unit for the direct
channel is lower than that of the retail channel, the retail channel
0.51
αh
;DFDÞ
thereby avoiding penalties that may result from the consumers’ Therefore, PðVM is the global optimal strategy if
preference for the retail channel. cr Z cd þ 2b. &
In this paper, we incorporated the existence of a retail-captive
segment into channel selection models. In addition, we assumed Proof of Proposition 2. We show that PðV M
;RFDÞ
: R2RFD -R is
heterogeneous hybrid consumers. These extensions reflect actual concave and derive its global maximum. We then show that if
;RFDÞ
consumer market characteristics. Many consumers lack access to cd Zcr then PðV
M Z PðV;PDLÞ
M and PðV;RFDÞ
M Z PðV;DFDÞ
M .
the Internet or are not willing to use for product purchases for
The second derivative of PðV;RFDÞ
M with respect to Pr satisfies
many reasons. The results indicate that conditions under which
2
an exclusive direct channel is optimal are uncommon and the @ PðV;RFDÞ
M =@Pr2 ¼ 2ðar þ ah Þ o0
dual channel or the exclusive retail channel options are more Therefore, the solution to @PðV;RFDÞ
M =@Pr ¼ 0 given by
likely to be optimal. Our analysis indicates that the size of the
PrðV ;RFDÞ ¼ 1
2ð1 þcr Þ is a global optimum of PðV;RFDÞ
M . Also, Pd can be
retail-captive segment plays a critical role in channel choices. The
cost advantage of a direct channel may be easily offset by the loss set at any value that satisfies PrðV;RFDÞ PrðV;RFDÞ ra. Hence,
of the retail-captive segment. This necessitates having a retail PdðV ;RFDÞ ¼ PrðV;RFDÞ a þ e for any e Z 0. Using pðP; cÞ defined in
channel open. (A.1), the optimal profit for the retail-focused dual strategy can be
The strong preference of consumers for the retail channel, with written as
the existence of a sizable retail-captive segment, may explain
some of the reasons for the predictions of e-commerce not being PðV;RFDÞ
M ¼ ðar þ ah ÞpðPrðV;RFDÞ ; cr Þ: ðA:3Þ
realized. Consumers who have not grown with the Internet may
be reluctant to use it for purchasing products. Over time, the size Suppose y^ is the optimal proportion of hybrid consumers served
of retail-captive segment is expected to decrease and preference on the retail channel in the optimal pure dual channel strategy.
for the direct channel is expected to increase. This implies that the Because cd Z cr results in p ðcr Þ Z p ðcd Þ and PrðV;RFDÞ ¼ P ðcr Þ, the
establishment of a direct channel may lead to an increase in the following holds:
market size. On the other hand, retailers are expected to resist
the establishment of a strong direct channel that competes with PðV;RFDÞ ¼ ðar þ y^ ah Þp ðcr Þ þ ð1y^ Þah p ðcr Þ
them, particularly when a retailer is dominant in the supply chain. Zðar þ y^ ah ÞpðPrðV;PDLÞ ; cr Þ þ ð1y^ Þah p ðcd Þ
Finding optimal distribution strategies under those conditions is
Zðar þ y^ ah ÞpðPrðV;PDLÞ ; cr Þ þ ð1y^ Þah pðPdðV ;PDLÞ ; cd Þ
an important area for future research.
¼ PðV;PDLÞ
M : ðA:4Þ
Acknowledgements
Similarly, PðV;RFDÞ
M Z PðV;DFDÞ
M can be also shown by setting
The authors would like to thank the referees for their helpful ^y ¼ 0. &
comments and suggestions. The third author (Gangshu Cai)
gratefully acknowledges support from the National Science Proof of Lemma 1. . From Eq. (27), the sign of cPD ðcd þ 2bÞ
Foundation through Grant 0927591. depends on the sign of the numerator, which is
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
að1c1 Þ þ2ar R ½2ar Rþ að1c1 Þ2 þ 8ar ab½1c1 þ b:
Appendix A
The square root term is greater than or equal to the first two
terms if 1ðc1 bÞ Z0.
Proof of Proposition 1. We show that PðV;DFDÞ : R2DFD -R is The inequality, 1ðc1 bÞ Z 0, or equivalently 1cd Z b, holds if the
concave and derive its global maximum. We then show that direct price in Pd A ½0; 1 is greater than or equal to b because
;DFDÞ ;PDLÞ
PðV
M 4 PðV
M and PðV;DFDÞ
M 4 PðV;RFDÞ
M for cr Z cd þ 2b. Now let 1cd Z Pd cd Z b. Therefore, if Pd cd Zb, then
us define a function cPD rc1 ¼ cd þ 2b. &
pðP; cÞ ¼ ð1PÞðPcÞ; 0 oP o 1; ðA:1Þ Proof of Proposition 3. Substituting Pr ¼ Pd þ d into PðV;PDLÞ and
M
which is concave and has a maximum at P ðcÞ ¼ 12ð1 þ cÞ of p ðcÞ ¼ taking the first derivative w.r.t. Pd to obtain the necessary
condition for Pd to be optimal yields
ð1cÞ2 =4 for any c o 1. The profit of the direct-focused strategy
can be written as PðV;DFDÞ ¼ ar pðPr ; cr Þ þ ah pðPd ; cd Þ which is the a½a þcd ah þ ar ðcr 2dÞ þ ah dðcr cd 2dÞbað1þ cr 2dÞ
M PdðV ;PDLÞ ¼ :
2Ra
sum of two concave functions on ðPr ; Pd Þ, and therefore PðV;DFDÞ
is
M ðA:5Þ
also a concave function on ðPr ; Pd Þ.
The global maximum of PðV;DFDÞ M : R2DFD -R is obtained by Substituting for PdðV;PDLÞ into PðV;PDLÞ
M gives PðV;PDLÞ
M ðPdðV;PDLÞ ; dÞ.
optimizing the profit from the direct channel given by ah pðPd ; cd Þ Taking the first derivative of PðV;PDLÞ ðPdðV ;PDLÞ ; dÞ w.r.t. d and
M
and the profit from the retail channel given by ar pðPr ; cr Þ which evaluating it at d ¼ b gives
gives (23). Since cr Zcd þ2b, PdðV;DFDÞ PrðV;DFDÞ Zb is satisfied.
Suppose y^ is the optimal proportion of hybrid consumers who dP ðV;PDLÞ
M ðPdðV;PDLÞ ; d ¼ bÞ
use the retail channel in the pure dual channel. Because dd
cr Z cd þ 2b results in PrðV;DFDÞ ¼ P ðcr Þ and PdðV;RFDÞ ¼ P ðcd Þ, the
ah ½2b2 a þ2bað1c1 Þ þðc1 cr Þðah c1 þðcr 2RÞar aÞ
¼ : ðA:6Þ
2aR
following must hold:
Solving dPðV;PDLÞ
M ðPdðV;DFDÞ ; d ¼ bÞ=dd ¼ 0 w.r.t. cr yields
PðV
M
;DFDÞ
¼ ðar þ y^ ah Þp ðcr Þ þ ð1y^ Þah p ðcd Þ qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
að1c1 Þ þ2ar ðc1 þRÞ 7 4R2 a2r þ a2 ðc1 1Þ2 þ 4ar a½2b þ Rþ 2b2 c1 ð2b þRÞ
Z ðar þ y^ ah ÞpðPrðV;PDLÞ ; cr Þ þ ð1y^ Þah pðPdðV;PDLÞ ; cd Þ 7
cPD ¼
2ar
:
;PDLÞ
¼ PðV
M : ðA:2Þ ðA:7Þ
ARTICLE IN PRESS
M. Khouja et al. / Int. J. Production Economics 125 (2010) 84–95 95
pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
Inside the range of the two roots, dPðV;PDLÞ ðPdðV;DFDÞ ; d ¼ bÞ=dd 4 0. ½ð8ZÞ þ 64 þ Z2 =Z2 . If 0 o 8 o Z then ah;2 41 and 0:5 o ah;1 o 1
M
;PDLÞ ðV ;PDLÞ and ah;1 is the root of interest. D1 Z 0 for 0:5 o ah;1 o1 and since
Thus, if cd rcPD rcr rcd þ2b and d 4b then PðV
M ðPd ; dÞ
;PDLÞ ðV ;PDLÞ
ah þ ar ¼ 1, ah Z ar must hold. &
o PðV
M ðPd ; bÞ and the optimal solution is given by solution
(a) in Proposition 3 or is in R2PDL . & Proof of Proposition 5. As Z increases, the range of strength of
consumers’ preferences increases. Since
Proof of Proposition 4. Suppose cd ocr ocPD and the optimal ,
dah;1 16
solution is in R2DFD then by Proposition 2, PrðV;DFDÞ PdðV;DFDÞ ob and ah;1 ¼ pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi 4 0 for Z o 8: ðA:12Þ
dZ 64 þ Z2 þð8ZÞ 64 þ Z2
therefore the solution must exist at the boundary of R2DFD where
;PDLÞ
Pr ¼ Pd þ b and therefore PðV
M ¼ PðV;DFDÞ
M . Substituting Pr ¼ Pd þb An increases in Z requires a larger size of the hybrid segment to
into PðV ;DFDÞ
and taking first and the second derivatives w.r.t. Pd keep the direct channel more profitable. &
M
shows that the sufficient condition for optimality of Pd is given by
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