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ISSN 1059-1478|EISSN 1937-5956|16|00|0001
DOI 10.1111/poms.12549
2016 Production and Operations Management Society
Tat Y. Chan
Olin Business School, Washington University in St. Louis, One Brookings Drive, Campus Box 1133, St. Louis, Missouri 63130-4899, USA,
chan@wustl.edu
Michael Lewis
Goizueta Business School, Emory University, 1300 Clifton Road, Atlanta, Georgia 30322, USA, mike.lewis@emory.edu
his study examines the effects of a relatively new channel structure on prices and sales in a large department store,
which in recent years has switched the management of many of its product categories from a traditional retailer-managed system to a manufacturer-managed system. We find that the change caused overall retail prices to decrease. However, there was significant heterogeneity in the response across brands. In the cell phone category, brands with high
market shares and inelastic demand did not change prices. In the watch category, the retail prices of relatively low-end
brands decreased while the prices of premium brands increased substantially after the switch. In addition to sales
increases due to lower prices, we find that the channel structure change further caused sales to increase by 910% in the
cell phone category and by 1117% in the watch category. These results are consistent with previous theoretical predictions. We believe that our results provide important academic and managerial implications due to the increasing prevalence of manufacturer-managed systems in the retail industry.
Key words: retailing; channel management; decision delegation; empirical study; marketing
History: Received: January 2015; Accepted: December 2015 by Amiya Chakravarty, after three revisions.
1. Introduction
In a traditional retail channel structure, a retailer
typically sells multiple differentiated products produced by multiple manufacturers. Manufacturers
determine wholesale prices and the retailer selects
order quantities, sets retail prices, conducts in-store
promotions and manages the sales staff. We refer to
this traditional structure as a retailer-managed retail
(RMR) system because the retailer determines and
manages the marketing environment faced by consumers. This structure may be advantageous
because retailers typically have better information
about consumer demand in the local market and
possess core competencies in retailing activities such
as merchandising and promotion planning. In addition, previous research (Coughlan 1985, McGuire
and Staelin 1983) has found that using a retailer as
an intermediary may reduce competition between
manufacturers and may thereby be preferable for
manufacturers whose products are highly substitutable. However, RMR suffers from well-known
channel coordination issues such as double-margin-
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
2. Literature Review
Our research contributes to the operations and marketing literature on channel management. The current
literature does not provide adequate analysis of the
increasingly popular phenomenon in practice, that is,
MMR. To the best of our knowledge, this is the first
empirical study to directly test the consequences of
MMR systems.
Our research is closely related to the vertical relationship and channel coordination literatures. As previously mentioned, a widely recognized channel
coordination issue is the double-marginalization
problem, that is, retailers charge higher retail prices
than the optimal level which maximizes total channel
profits (Shepard 1993, Spengler 1950). Numerous theoretical studies have focused on how to use various
transfer pricing schemes or other formal agreements
to improve channel coordination (e.g., see Cachon
2003, Cachon and Lariviere 2005). Policies such as
implicit understanding (Shugan 1985), formation of
conjectures (Jeuland and Shugan 1988) and category
captainship (Kurtulus et al. 2014, Subramanian et al.
2010) have also been studied. However, those models
are seldom empirically tested in the marketplace due
to the lack of data. Moreover, the majority of studies
in this literature focuses on the case of a monopoly
manufacturer.
In reality, retailers such as the department store in
our data, typically sell multiple differentiated products. McGuire and Staelin (1983) show that in a market with duopoly manufacturers, vertical integration
is a stable equilibrium channel structure when interbrand substitutability is low, though it does not necessarily maximize the total profit for the channel. When
products are highly substitutable, however, independent retailers provide a buffer that reduces the price
competition between manufacturers. Coughlan (1985)
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
Production and Operations Management 0(0), pp. 113, 2016 Production and Operations Management Society
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
1
2
3
4
5
6
7
8
9
10
Mean
Min
Max
Mean
Min
Max
Mean
Min
Max
Average
weekly
feature ad.
19.46
17.90
12.83
12.03
6.18
4.58
4.21
2.13
1.40
1.88
15.72
11.92
8.26
9.87
3.17
1.03
1.88
1.29
0.75
0.56
25.99
25.82
22.77
16.37
8.42
6.49
5.95
4.64
2.60
2.49
3980
3292
1207
2724
636
464
789
380
329
258
3367
2959
992
2519
625
407
759
347
297
217
4394
3712
1539
2995
654
494
824
413
356
297
199.51
216.67
174.75
297.28
153.83
142.59
293.58
196.42
191.36
147.90
128.64
148.02
112.30
222.10
105.93
73.46
100.49
124.32
104.94
91.85
437.90
339.88
253.28
402.84
216.71
208.40
594.81
246.67
320.12
207.28
0.19
0.19
0.29
0.15
0.27
0.25
0.14
0.15
0.21
0.13
Average
no. of
models
49
55
33
15
15
13
21
12
19
22
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
Production and Operations Management 0(0), pp. 113, 2016 Production and Operations Management Society
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
Brand
1
2
3
4
5
6
7
8
9
10
11
12
13
Mean
Min
Max
Mean
Min
Max
Mean
Min
Max
Average
weekly
feature ad.
1.01
1.29
2.46
8.02
10.22
2.71
2.10
10.17
13.73
11.05
15.48
7.26
16.94
0.45
0.33
1.07
6.69
7.66
1.19
1.29
8.50
10.52
9.15
9.71
1.54
13.56
2.07
1.92
4.64
10.28
11.02
4.44
3.23
11.56
18.83
12.63
19.21
11.62
24.66
141,048
103,767
73,235
33,439
21,354
14,948
10,266
11,139
11,501
7591
5440
2965
2724
76,809
68,916
56,963
30,735
17,376
11,891
3853
10,237
10,063
6527
2511
1232
1938
30,3613
132,301
110,476
35,839
26,607
16,798
13,305
12,392
13,232
9222
7653
3984
4770
6632.75
2399.07
1988.06
736.65
514.72
376.07
290.33
278.52
277.32
171.17
95.31
89.31
55.64
2603.25
1301.63
1126.41
400.50
255.32
190.24
127.66
154.19
85.11
125.78
37.30
40.55
20.38
22,528.16
10,438.05
3379.22
1752.07
833.46
650.81
600.75
455.78
429.90
570.71
312.89
261.58
140.39
0.008
0.005
0.013
0.069
0.074
0.060
0.074
0.078
0.129
0.083
0.092
0.069
0.079
average retail prices increased as the result of increasing commodity prices. However, this price change
did not result in a decrease in sales. Similar to the cell
phone category, there is also significant heterogeneity
across brands. Average prices in the category range
from US$56 for brand 13 to $6633 for brand 1. The difference is so substantial that brand 1 generates the largest annual sales revenue even though its market
share in terms of quantity sales is only 1%. In contrast,
brand 13 has the largest quantity sales but its annual
revenue is the smallest in the store.
As noted, a key feature of the data is a switch from
RMR where the store determined retail prices, managed the inventory, and hired and managed sales
staff. Following the change to MMR all of these
responsibilities were shifted to individual manufacturers. For the cell phone category, the switch was
abrupt and applied to the whole category at the same
time. Prior to April of the fourth year all brands were
under RMR. At the end of February in that year, the
store made the decision to switch to MMR. Negotiation of revenue sharing contracts with individual
manufacturers began in March and the first brand
started switching to MMR in the middle of April. By
the end of April, all brands had switched to the new
retailing system.
In contrast, the switch to MMR in the watch category was a gradual process. Six major brands operated using MMR at the beginning of the data
collection period. One brand (brand 12) switched
from RMR to MMR in September of the first year. This
was followed by changes for brands 7 and 5. In
September of the third year, brand 1, the most expensive brand, was switched to MMR. The store then
switched brand 4, another high-end brand, in April of
year 4. At the end of the fourth year (the end of our
data collection period), only brands 2 and 3 were still
operated as retailer-managed brands.
Average
no. of
models
83
130
118
116
96
156
102
139
77
105
54
82
55
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
Model 1
Model 2
%0.107***
%0.107***
%0.019***
%0.126***
%0.186***
N/A
N/A
N/A
N/A
%0.001*
Watch category
Model 1
%0.043*
0.171***
0.341***
0.515***
N/A
Model 2
%0.033**
N/A
N/A
N/A
0.003***
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
Production and Operations Management 0(0), pp. 113, 2016 Production and Operations Management Society
Watch category
Parameters
Model 1
Model 2
Model 1
Model 2
Channel
structure change
Log(Own Price)
Brand 1
Brand 2
Brand 3
Brand 4
Brand 5
Brand 6
Brand 7
Brand 8
Brand 9
Brand 10
Brand 11
Brand 12
Brand 13
Log(Cross Price)
Advertising
New Models
Relocation 1
Relocation 2
Year 2
Year 3
Year 4
Weekly
Time Trend
0.102***
0.085**
0.111***
0.171***
%0.075***
%0.095***
%0.168*
%0.246***
%0.232**
%0.263**
%0.277***
%0.477***
%0.401**
%0.631***
%0.681***
%0.545***
%0.954***
0.071**
0.206***
N/A
N/A
N/A
0.076
%0.042
0.158
N/A
%0.185***
%0.112***
%0.277*
%0.382***
%0.390***
%0.331***
%0.469***
%0.507***
%0.544***
%0.829***
%0.953***
%0.816***
%1.450***
0.087***
0.223***
N/A
N/A
N/A
N/A
N/A
N/A
%0.001
%0.564***
%1.091***
%1.458***
%0.641***
%1.693***
%1.648***
%1.240***
%1.399***
%1.560***
%2.150***
N/A
N/A
N/A
0.227*
0.148***
0.022***
0.097***
%0.191***
%0.074***
%0.143***
%0.233***
N/A
%0.520***
%1.181***
%1.413***
%0.672***
%1.671***
%1.703***
%1.264***
%1.340***
%1.576***
%2.256***
N/A
N/A
N/A
0.04
0.157***
0.029***
0.074***
%0.225***
N/A
N/A
N/A
%0.001***
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
Production and Operations Management 0(0), pp. 113, 2016 Production and Operations Management Society
we did using the data from the control store. The idea
is that if a shock occurred within the store, it would
impact all categories on the same retail floor in the
same way. The results are reported in Panel (2) and
Panel (3) of Table 5, respectively. None of the results
is significant, and three out of the four coefficients for
the sales regression are negative.4
4.4.3. Competitive Environment. Another potential explanation for our results is that the price and
sales changes were driven by changes in the competitive environment inside and outside the department
store over time. For example if there were more
entrant brands than exit brands in the store we might
expect a more intensive within-store competition in
the later part of our sample period. This type of effect
could also produce a negative coefficient for the channel structure change parameter in the price regression. In the data there were 62 brands in the cell
phone category before the switch, and only five small
brands (average annual market share of the largest of
these brands is 0.8%, and the total market share of the
five brands is 2.4%) left after the switch. It is unlikely
that these five small brands would have significant
impact on the intensity of competition in the category.
Furthermore a reduction in the total number of
brands should mitigate rather than increase competitive pressures. For the watch category, the total number of brands was stable before and after the switches
so again it does not explain the observed price
changes.
Competition outside the store that is not captured
by the time variables in the regressions may be
another factor. A decrease in competition might
explain why the coefficient for the channel structure
change is positive in our sales regressions. We explore
this possibility by selecting data from 1 month before
and 1 month after the changes to MMR in the cell
phone and watch categories to run the price and sales
regressions again. This practice is similar to the regression-discontinuity approach in the literature.
The logic is that while outside competition may have
changed over time, if the change was continuous and
Table 5 Main Results of Price and Sales Regressions for Control Store and Categories
(1)
Regression
Control
variables
Artificial switch
dummy
(2)
(3)
Log (Price)
Sales
Yearly and monthly
dummies
Log (Price)
Sales
Weekly time
trend
Log (Price)
Sales
Yearly and monthly
dummies
Log (Price)
Sales
Weekly time
trend
%0.092
%0.131
0.141
%0.156
0.012
%0.048
0.014
%0.053
0.067
0.058
0.072
0.062
10
Watch category
%0.032
0.054
%0.032
%0.177***
%0.180***
%0.294*
%0.461***
%0.358***
%0.537***
%0.576***
%0.567***
%0.624***
%1.219***
%0.833***
%2.084***
0.043
pit
c1
10
C
X
bi Xit0 vc cc1 pit cc2 cpit dc sit ncit
c1
20
N
X
log
i1
C
X
c1
(ff qit % bi %
Pci (
T
Y
t1
Xit0 vc
cc2 cpit
!
% d sit ;
c
AIC
The p-value of
statistical test
BIC
Bootstrapped parametric
likelihood ratio test
975.98
1174.21
1266.74
1324.69
0.00
0.00
1.00
1.00
5869.87
5722.13
5817.51
5982.94
0.00
0.00
0.23
1.00
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
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Production and Operations Management 0(0), pp. 113, 2016 Production and Operations Management Society
Class 1
%0.259***
0.109***
%1.983***
1.338***
0.382***
0.097***
5, 6, 7, 8, 9, 10
Watch category
Class 2
Class 3
Class 1
Class 2
Class 3
%0.030
0.063**
%1.228***
0.713**
0.034
0.010
4
%0.048*
0.025**
%1.178***
0.237
0.213***
0.135***
1, 2, 3
%0.275***
0.216***
%1.515***
1.096***
0.215***
N/A
11, 12, 13
%0.069***
0.141***
%0.470***
0.024
0.113**
N/A
4, 5, 6, 7, 8, 9, 10
0.212***
0.118***
%0.272
0.012
0.204***
N/A
1, 2, 3
6. Conclusions
MMR has become a prevalent retailing system in Asia
and is growing in popularity in other parts of the
world including the United States. Under this system,
retailers delegate many decisions, including inventory management, pricing and sales staff hiring, to
manufacturers. MMR has been proposed as a potential solution for channel conflicts between retailers
and manufacturers.
We empirically study the effects of a switch from
RMR to MMR on retail prices and sales in the cell
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
12
Acknowledgments
We are very grateful to the Department Editor and the
Senior Editor for their invaluable guidance, and the two
anonymous reviewers for their helpful suggestions. We also
thank participants at 2008 Marketing Science Conference
and Marketing Scholar Forum VIII, and seminar participants at Fudan University and University of Minnesota for
their thoughtful comments on previous versions of this
article.
Notes
1
During our sample period, the store only sold cell phone
hardware. Consumers had to subscribe to wireless
services from wireless communications service providers
separately.
2
Their model assumes that retailers charge manufacturers an up-front fixed rent, which is different from the
MMR system under which retailers charge manufacturers a percentage of sales revenue. We develop an analytical model where two (symmetric) manufacturers sell
to one retailer. The retailer initiates a revenue-sharing
contract to manufacturers under the constraint that manufacturers profits are positive. We find that the equilibrium retail prices under MMR are always lower than
that under RMR. Since this model set-up is similar to
theirs, we choose not to include it in this study to save
space. Detailed results are available from the authors
upon request.
3
The store does not carry cell phones so we cannot compare for the category.
4
That said, we cannot rule out the possibility that the
demand or cost shocks are specific for the store and for
the cell phone and watch categories only.
5
To investigate whether these results are driven by revenue-sharing in contracts, we further collect information
on revenue sharing for the cell phone category. There are
variations across brands. Brands 1, 2, and 4 pay 22.5% revenues to the store. Brands 3 and 7 pay 25%, and the rest
of five smaller brands pay 26%. If the price changes were
only caused by the revenue sharing contract, brands 1, 2
and 4 would lower prices more than other brands after
the channel structure switch, since they pay less to the
store. Results from Table 8, however, show that Class 1
brands (brands 510) lower prices the most after the
switch. This suggests that revenue sharing contracts and
price changes may be simultaneously driven by brandspecific factors: Since Class 1 brands have small market
shares (see Table 1), they have lower bargaining power
when negotiating the contract with the department store.
Also, since the price sensitivity of those brands is higher
than for other brands (see Table 8), they have greater
incentive to lower prices to compete for market share
shares after the channel structure switch. Had the revenue
shares been fixed to be the same for all brands, Class 1
brands would have lowered prices even more than in the
results in Table 8.
Please Cite this article in press as: Li, J., et al. What Happens When Manufacturers Perform The Retailing Functions?. Production and
Operations Management (2016), doi 10.1111/poms.12549
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