When Franchisee's Service Affects Demand: An Application to the Car Radiator Market and Resale Price Maintenance

Abstract

It is well understood that the downstream firm's service can impact the performance of vertical channels. While many academic works address the service provision of the downstream firm, empirically quantifying the impact has been challenging, because the downstream firm's service is often unobservable to the researcher. I propose a new empirical framework that incorporates the downstream firm's unobserved endogenous service provision by modifying the standard demand model. I apply this empirical framework to proprietary data from a franchise network in the car radiator market to quantify the downstream firm's (e.g., franchisee's) endogenous service. Counterfactuals under maximum resale price maintenance (RPM) policies show that the standard demand model ignoring the franchisees' endogenous service reduction (i.e., service externality) results in overly optimistic counterfactual predictions than the developed framework does. Such service externality can be mitigated if the service provision cost is lower for franchisees. Last, I examine boundary conditions: under the extreme regime of maximum RPM aiming to fully extract franchisees' profit; I find that information asymmetry is a greater concern for the upstream firm within the focal industry. Additionally, when service externality is combined with channel information asymmetry, maximum RPM at such extremes may no longer increase franchisor's profit.

Keywords: services marketing; unobservable service; endogenous service; franchise; business-to-business (B2B) marketing; car radiator industry; service; maximum resale price restraint; resale price maintenance; channel relationship; vertical channel; vertical control; choice modeling; empirical IO; endogeneit