How Does Free Riding on Customer Service Affect Competition?

Abstract

The free-riding problem occurs if the presales activities needed to sell a product can be conducted separately from the actual sale of the product. Intuitively, free riding should hurt the retailer that provides that service, but the author analytically shows that free riding benefits not only the free-riding retailer but also the retailer that provides the service when customers are heterogeneous in terms of their opportunity costs for shopping. The service-providing retailer has a postservice advantage, because customers who have resolved their matching uncertainty through sales service incur zero marginal shopping cost if they purchase from the service-providing retailer rather than the free-riding retailer. Moreover, allowing free riding gives the free rider less incentive to compete with the service provider on price, because many customers eventually will switch to it due to their own free riding. In turn, this induced soft strategic response enables the service provider to charge a higher price and enjoy the strictly positive profit that otherwise would have been wiped away by head-to-head price competition. Therefore, allowing free riding can be regarded as a necessary mechanism that prevents an aggressive response from another retailer and reduces the intensity of price competition.

Keywords: free riding, sales service, selling cost, channel conflict, retail competition, competitive strategy, and game theory

JEL Classification: L13, M31