Boiling Frogs: Pricing Strategies for a Manufacturer Adding a Direct Channel that Competes with the Traditional Channel

In this paper, we analyze a scenario where a manufacturer with a traditional channel partner (i.e., a retailer) opens up a direct Internet channel that is in competition with the traditional channel partner. We first consider that in order to mitigate channel conflict the manufacturer, who chooses wholesale prices as a Stackelberg leader, commits to setting a direct channel retail price that matches the retailer's price in the traditional channel. Under this general equal-pricing strategy, we determine the effect of more specific pricing strategies on prices and profits of the manufacturer and the retailer. These specific strategies are: (1) keep wholesale prices as they were before, (2) keep retail prices as they were before, or (3) select wholesale and retail prices that optimize profits for the manufacturer. Within these strategies we identify and summarize cases when the resulting prices are lower than the pre-Internet prices, and when they are higher, relating them to the respective channel costs and to the relative convenience to the consumer of the Internet channel. We find that Strategy 3 – the specific equal-pricing strategy that optimizes profits for the manufacturer – often is also preferred by the retailer and customers (through lower prices) over the other equal-pricing strategies. We next consider the implications of the equal-pricing constraint through a numerical experiment that indicates that the equal-pricing strategy is appropriate as long as the Internet channel is significantly less convenient than the traditional channel. If the Internet channel is of comparable convenience to the traditional channel, then the manufacturer has tremendous incentive to abandon the equal-pricing policy – at great peril to the traditional retailer.