The Effect of Probabilistic Selling on Channel Dynamics in Supply Chains

Abstract

Problem definition: Probabilistic selling (PS) is a business model whereby, in addition to selling transparent products, a firm sells an opaque good, which is unknown to buyers until after purchase. We examine how PS affects retailer-manufacturer interactions in markets for physical goods and how upstream competition impacts channel members’ incentives to facilitate PS. Methodology/results: Using a Hotelling-based model of a multiproduct retailer, we find that a retailer maximizes its profit by assigning equal probability to each product even when the products have different wholesale prices. We also find that PS mitigates the inefficiencies caused by the double-marginalization problem. Although the potential benefit from PS is greater for a decentralized channel than for a centralized one, the market conditions for which PS arises are narrower for a decentralized channel. Furthermore, PS shifts channel power toward the manufacturer. However, it is possible for a win-win-win outcome to arise in which the manufacturer, retailer, and consumers benefit from PS. As expected, upstream competition shifts channel profit toward the retailer. However, competition also has surprising effects: It shrinks, rather than expands, the viability of PS and makes it possible for each manufacturer to benefit from its rival’s cost reduction. Managerial implications: A manufacturer should induce the retailer to offer an opaque good if its production costs are sufficiently low and the products are sufficiently close substitutes. It is optimal for the manufacturer to increase (decrease) its wholesale prices in response to the retailer’s ability to offer opaque goods if product differentiation is low (modest). Setting a wholesale price below cost sometimes maximizes a manufacturer’s profit. Furthermore, a retailer can achieve a strategic advantage by using products from multiple manufacturers to construct opaque goods. However, the retailer’s ability to leverage this advantage is curtailed because its use of equal-probability assignments relaxes competition between manufacturers. Funding: S. Fay acknowledges the financial support from the Earl V. Snyder Innovation Management Center and the Robert H. Brethen Operations Management Institute, Whitman School of Management, Syracuse University. Supplemental Material: The e-companion is available at https://doi.org/10.1287/msom.2022.0158 .