Implications of Product Substitutability in a Distribution Channel

Production and Operations Management, Forthcoming

40 Pages Posted: 9 Mar 2021 Last revised: 23 Oct 2022

See all articles by Quan Zheng

Quan Zheng

University of Science and Technology of China - School of Management

Honggang Hu

Tongji University - Advanced Institute of Business

Xiajun Amy Pan

University of Florida - Warrington College of Business Administration

Date Written: February 16, 2021

Abstract

This paper examines the effect of product substitutability on the equilibrium profits in a distribution channel of two symmetric manufacturers selling substitutable products to consumers through a nonexclusive retailer. Conventional wisdom suggests that when the products are more substitutable, the retailer will be better off while the manufacturers will be worse off, owing to the dominance of the competition effect of substitutability. In this work, we identify the hitherto neglected demand effect of substitutability and show that the relative strength between the competition and demand effects is the key to this result. As the products become more substitutable, the upstream competition does intensify, but vitally, the demand may expand. We show that the interests of the retailer and manufacturers can be aligned in terms of product substitutability, depending on both the demand and supply factors. Surprisingly, the conventional result can even be completely reversed such that the manufacturers benefit from a certain level of substitutability for some demand patterns. Assuming linear demand, we further isolate the important role of the bargaining power balance and the alternative of agency selling format in moderating the competition effect. For example, as the retailer gains more bargaining power, the (negative) demand effect can overshadow the (positive) competition effect such that a higher degree of substitutability can actually hurt the retailer. Our findings provide valuable implications for persuasive advertising and category management.

Keywords: channel management; product substitution; retailing; category management; persuasive advertising

Suggested Citation

Zheng, Quan and Hu, Honggang and Pan, Xiajun, Implications of Product Substitutability in a Distribution Channel (February 16, 2021). Production and Operations Management, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3786473 or http://dx.doi.org/10.2139/ssrn.3786473

Quan Zheng (Contact Author)

University of Science and Technology of China - School of Management ( email )

Hefei, Anhui
China

Honggang Hu

Tongji University - Advanced Institute of Business ( email )

Siping Road 1500
Shanghai, 200092
China

Xiajun Pan

University of Florida - Warrington College of Business Administration ( email )

Gainesville, FL 32611
United States

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