The bright side of having an enemy

Abstract

Conventional wisdom suggests that more intense competition will lower firms’ profits. We show that this may not hold in a channel setting with exclusive retailers. We find that a manufacturer and its retailer can both become worse off if their competing manufacturer and retailer with quality-differentiated products exit the market. Put differently, in a channel setting, more intense competition can be all-win for the manufacturer, the retailer, and the consumers. Interestingly, a high-quality manufacturer can benefit from an increase in its competitor’s perceived quality, e.g., due to favorable product reviews from consumers or third-party rating agencies. In other words, a manufacturer may prefer a strong rather than a weak enemy and the manufacturer can have an incentive to help its competitor to improve product quality or to remain in the market. Furthermore, we show that a multi-product monopolist manufacturer with an exclusive retailer may make higher profits by spinning off a product into a competing manufacturer that has its own retail channel, even without accounting for any proceeds from the spinoff.

Keywords: Competitive Strategy, Market Exit, Channel, Double Marginalization, Pricing, Entry Deterrence

JEL Classification: D01,D21, D40,D43,