Dual Channel Distribution: The Case for Cost Information Asymmetry

Abstract

Dual channel distribution benefits upstream manufacturers but may irritate downstream retailers. The channel conflict only seems to aggravate when retailers are put at information disadvantage. We show this need not be the case. (i) We demonstrate upstream private information can improve channel efficiency and consumer surplus. The main mechanism is the offsetting interplay of signaling distortion and double marginalization: with private selling cost, the manufacturer may signal her cost by cutting the wholesale price; the price cut encourages the retailer to buy more, thereby reducing double marginalization and improving channel efficiency. (ii) We qualify the received wisdom. The general insight that cost information asymmetry reduces efficiency does not work in dual-channel settings. We show incorporating cost information asymmetry can change dual-channel equilibrium substantially — it can turn the retailer and channel from the victims of manufacturer encroachment to its beneficiaries. Also, we rationalize why the retailer can benefit from his information disadvantage, and when he can gain from the manufacturer's selling cost improvement, despite retail competition. (iii) We demonstrate our results are robust for other prevailing arrangements, e.g., two-part tariffs, price competition, imperfect substitution, and simultaneous moves. Our results suggest a more nuanced view of manufacturer encroachment: as private cost information can ease channel conflict and improve consumer surplus, previous studies may have overestimated the harm of encroachment. By highlighting the critical role of cost information asymmetry, this study sharpens our understanding of dual-channel theory and practice.