Supplier encroachment with decision biases

Abstract

The retail market is being increasingly invaded by suppliers who are establishing their own direct selling channels, thanks to the rise of e-commerce and internet technology. The cost of direct sales has been identified as a crucial factor in the strategic interaction between suppliers and retailers. However, retailers often struggle to accurately assess this cost due to their decision biases. To address this issue, we propose a strategic mental model to examine how these biases impact supplier encroachment and firms’ performance outcomes. Our analysis reveals that a retailer can benefit from having an underestimation bias. Additionally, the bias of one firm can benefit the other, depending on whether it is an underestimation or overestimation bias. Interestingly, both the supplier and the retailer can earn more when they are biased compared to when neither of them is biased, resulting in a win-win scenario. However, if the supplier fails to recognize the retailer’s bias, the possibility of mutual gains is eliminated. Furthermore, when biases are present, the option of encroachment may backfire for the supplier compared to the scenario without encroachment, and the retailer may be worse off in the sequential encroachment setting compared to the simultaneous setting. Finally, we extend our model by considering imperfect substitutability between the retailer’s and supplier’s products, and the main conclusions remain robust. Our findings suggest that considering these biases alters the nature of strategic dynamics and provides new insights into supplier encroachment and information management.