Resale Price Maintenance in the Age of Showrooming
Jeanine Miklós‐Thal (University of Rochester)
Greg Shaffer (University of Rochester)
July 2015
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What is resale price maintenance?
Resale price maintenance (RPM) is a firm strategy whereby a manufacturer sets the price at which its distributor(s) must sell its product to consumers.
Minimum RPM involves the manufacturer setting a price floor for its distributors, maximum RPM involves the manufacturer setting a price ceiling.
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Legal treatment and economic theories
RPM used to be per se illegal in the United States, but has been judged on a “rule of reason” basis since the 2007 Leegin decision. Anti‐competitive theories
Pro‐competitive theories
Collusive theories of harm (Yamey 1954)
‐ Retailer cartel ‐ Manufacturer cartel Service‐based theories
justification
‐ free‐riding arguments (Telser 1960)
‐ non‐price competition (Winter 1993, Iyer 1998)
Exclusion‐based theories of harm (Bowman 1955)
‘Outlets hypothesis’ (Gould & Preston 1965)
leading Retailer quality certification (Marvel & McCafferty 1984)
“Image theory” of RPM (Orbach 2008)
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The free‐riding theory and internet retailing
The free‐riding theory has been criticized for being of limited applicability in many product categories where RPM has appeared: fashion apparel, pet food, toys,…
“In the case of clothing, for example, “services” include fitting rooms, sales staff and prominent or central display in department stores. These services are not realistically subject to the free‐
riding problem.” (Mathewson and Winter, 1998)
“…many observers argued that consumers do not really go to one store to try on jeans and then buy the same pair elsewhere.” (Klein, 2009)
Internet retailing has the potential to increase the applicability of the free‐riding theory because there is an inherent asymmetry between brick‐and‐mortar and online distribution.
• Showrooming (= the practice of visiting an offline retailer in order to examine a product before buying it online at a lower price) is gaining popularity rapidly.
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Showrooming and vertical restraints
Restrictions imposed on online retailers are viewed as a way to solve the “showrooming (= free‐riding) problem” and ensure efficient service provision at brick‐and‐mortar outlets.
“The emergence of the internet as a new distribution channel requires manufacturer to develop restrictions on Internet retailers to control free‐riding.” (Carlton and Chevalier, “Free riding and sales strategies for the internet”, Journal of Industrial Economics, 2001).
“Resale price maintenance eliminates the incentive of consumers to first obtain free services, such as product demonstrations, at full‐service retailers before buying the product a low‐service retailers, because low‐service retailers cannot discount price. As a result, retailers capture a greater return on their retailing efforts and are incentivized to supply increased amounts of the retailing services that are desired by consumers and the manufacturer.” (Klein (2015), “Resale Price Maintenance of Online Retailing,” The Oxford Handbook of International Antitrust Economics.) 7
Contribution
In the classic free‐riding theory, the focus is on preventing the “discounter” from setting a low price.
This paper argues that this is not what the supplier wants to do when it deals with brick‐and‐mortar and online retailers. Instead, optimal supply contracts
• induce asymmetric retailer prices → some consumers showroom
• control the brick‐and‐mortar retailer’s service level by means of a price floor on the brick‐and‐mortar store (while allowing the online store to set a lower price)
In our model, service provision by the brick‐and‐mortar store can impose a negative externality on the online retailer (unlike in the classic free‐riding theories) ‐‐‐ in spite of this, the brick‐and‐mortar retailer is biased towards price competition and a price floor is needed to induce efficient service provision.
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Outline of Talk
• Model description
• Analysis
1. Industry monopoly outcome (= vertical integration outcome)
• Does the industry monopoly outcome involve showrooming?
2. Is RPM needed for channel coordination?
• Contract with the brick‐and‐mortar retailer
• Contract with the online retailer
• Discussion and conclusion
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Model: Setting
Industry with a single supplier and two retailers: • a brick‐and‐mortar retailer B, • an online retailer O.
B can offer point‐of‐sale services that enhance consumers’ willingness to pay for the supplier’s brand (purchased at either retailer). O cannot provide similar services.
• Service level δ implies a marginal cost per visitor s(δ) for B.
• s() is increasing and convex, s(0) = s’(0) = 0
All other downstream marginal costs are symmetric (or lower online).
Upstream marginal costs are normalized to zero.
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Model: Consumer Demand Consumers differ in their shopping costs. A consumer with cost of visiting B and cost of visiting O obtains the following utilities from the different available options:
1. Buy from the brick‐and‐mortar store:
2. Buy from the online store directly:
3. Showrooming (visit B, then buy from O):
4. Outside option:
0
Each consumer chooses the option that yields her the highest utility.
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Model: Consumer Demand cont.
• Types of services to think about:
‐ Product demonstrations
‐ Sales assistance (to determine best fit, select features etc.)
‐ Sales effort (enthusiasm)
‐ Prominent in‐store display
‐ Fitting rooms
(Model can be reformulated such that service allows consumers to find out whether they like the product and thus avoid costly returns)
• Shopping costs follow a joint distribution
– Talk focuses on cases in which
,
,
with ,
0.
has full support on 0,
where
.
• If were heterogeneous across consumers, we would have to work with the joint distribution of and (instead of and ).
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Consumer choices for buy nothing
BM
BM = brick‐and‐mortar
OD = online direct
SR = showrooming OD
SR
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Consumer choices for BM
buy nothing
SR
BM = brick‐and‐mortar
OD = online direct
SR = showrooming OD
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Consumer choices for BM
buy nothing
BM = brick‐and‐mortar
OD = online direct
SR = showrooming SR
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Model: Timing and vertical contracting
Timing:
1. The supplier makes simultaneous take‐it‐or‐leave‐it supply contract offers to the retailers. Offers are observable. 2. The retailers simultaneously decide whether to accept the supplier’s offers.
3. The retailers simultaneously set their retail prices and and B chooses its service level .
Lump‐sum transfers (e.g., franchise fees, slo ng fees) are feasible → contrac ng is efficient.
We will ask whether resale price maintenance imposed on one or both retailers is needed to achieve channel coordination.
• Service is non‐contractible.
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Analysis: What’s the optimal level of showrooming?
Question: Does the efficient outcome (from the point of view of the firms) involve showrooming?
To answer this question, it will be useful to consider a benchmark model in which the benefit from
point‐of‐sales services is store‐specific rather than brand‐specific:
1. Buy from the brick‐and‐mortar store:
→ no showrooming
regardless of prices
2. Buy from the online store directly:
3. Showrooming (visit B, then buy from O):
4.
0
Outside option:
Assume the industry profit
its unique maximum at
,
,
,
, in the benchmark model is strictly quasi‐concave and reaches
with
.
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What’s the optimal level of showrooming?
Result 1: The industry monopoly outcome involves showrooming by a positive mass of consumers. Outline of proof: starting from symmetric retail prices, consider the impact on the industry profit (in our model) of
• marginally increasing , and/or
→ some consumers begin to showroom
• marginally decreasing .
Will argue that at least one of these marginal price changes raises industry profits.
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Demand pattern for buy nothing
BM
OD
If , profits in our model are identical to those in the benchmark model with store‐specific services.
= 0
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Marginal increase in starting from buy nothing
BM
OD
= 0
SR
A slight increase in has three effects on demand:
1. Some consumers switch from BM to SR
2. Some consumers switch from BM to OD
3. Some consumer switch from BM to nothing.
The first‐order effect of 1 on industry profits is zero:
‐ Same costs, because BM and SR buyers both consume B’s service
‐ No first‐order effect on revenues as .
The marginal effect on industry profits is the same as in the benchmark model with store‐specific service.
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Marginal decrease in starting from buy nothing
BM
OD
= 0
SR
A slight decrease in has three effects on demand:
1. Some consumers switch from BM to SR
2. Some consumers switch from BM to OD
3. Some consumer switch from nothing to OD.
The first‐order effect of 1. on industry profits is zero:
‐ Same costs, because BM and SR buyers both consume B’s service
‐ No first‐order effect on revenues as .
The marginal effect on industry profits is the same as in the benchmark model with store‐specific service.
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Implications of graphical analysis
1. Starting from symmetric retail prices, the impact of a marginal increase in on industry profits is the same as in a benchmark model with store‐specific services.
2. Starting from symmetric retail prices, the impact of a marginal decrease in on industry profits is the same as in a benchmark model with store‐specific services.
Since the industry profit‐maximizing prices in the benchmark model are asymmetric, 1. and 2. imply that industry profit‐maximizing prices are asymmetric in our model as well.
→ A posi ve mass of consumers showroom at the industry monopoly outcome.
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Channel coordination
• To coordinate the distribution channel, the supplier needs to design contracts that
1) Maximize total channel profits
2) Transfer the profits at the retail level back to the manufacturer
• 2) can be achieved via infra‐marginal transfers (fixed fees) • 1) requires that contracts induce the retailers to set the retail prices (
level that maximize
, , +
, , +
Assume unique global maximum, denoted by ∗ , ∗ , ∗ .
,
) and service ,
,
• Questions: Is RPM useful/necessary to induce the integrated monopoly outcome? If so, which form(s) of RPM?
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Contract with the brick‐and‐mortar store
Consider the contract with B, assuming that the contract with O is such that O’s best response to ∗ , ∗ is ∗ . How can the supplier induce B to choose ∗ , ∗ ?
Result 2: A wholesale price alone is insufficient to induce the efficient retail price and service level at B. A wholesale price and a price floor (min RPM) are sufficient.
Note: A price floor is needed even though the cross‐elasticity of demand with respect to service can be negative!
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Outline of proof
,
Denote B’s variable profit by ,
,
,
.
B’s incentives are distorted from the collective optimum by two externalities:
→B is biased towards price competition if (at the industry optimum),
(similar to Winter 1993; Krishnan and Winter 2007)
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Impact of price decrease at B buy nothing
product margin
BM
inter‐retailer margin
OD
SR
) Effects of a marginal decrease in B’s price
on demand:
1. Some consumers switch from SR to BM
2. Some consumers switch from OD to BM 3. Some consumers switch from nothing to BM
All three effects increase B’s demand.
Effect 3 increases market demand.
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Impact of service improvement at B buy nothing
product margin
BM
inter‐retailer margin
OD
SR
)
Effects of a marginal increase in B’s service level on demand:
1. Some consumers switch from OD to SR
2. Some consumers switch from OD to BM
3. Some consumers switch from nothing to BM.
Only effects 2 and 3 increase B’s demand.
Effect 3 increases market demand.
O’s demand decreases (negative externality on the online retailer)!
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Intuition and implications
In the case analyzed so far, B is biased towards price competition not because of a positive externality on O, but because the consumers at the inter‐retailer margin who are indifferent between BM and SR
• respond to changes in relative prices • but do not respond to changes in B’s service level (which they consume regardless)
To offset B’s bias towards price competition, the supplier needs to impose a price floor (or a fixed resale price) on B. The wholesale price can then be adjusted downwards so as to elicit the optimal service level. However, because the efficient outcome involves showrooming, the supplier does not want to impose an industry‐wide price floor. 28
Service provision can also have a positive externality on O
)
BM
buy nothing
In this case, service provision by B has a positive externality on O!
Again, a price floor on B is needed.
SR
OD
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Contract with the online store
Consider the contract with O, assuming that the contract with B is such that B’s best response to ∗ is ∗ , ∗ .
Inducing O to set ∗ seems easy: The supplier needs to control only one decision of retailer O, and there exists a wholesale price such that the horizontal externality offsets the vertical externality and
0
However, a local maximum of may not be a global maximum…
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Demand functions have kinks
no consumers showroom
some consumers showroom
+
some consumers showroom
no consumers showroom
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Why do the demand functions have kink?
buy nothing
buy nothing
BM
BM
OD
OD
0
SR
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Implications
Suppose the supplier sets the wholesale price such that ∗ maximizes O’s variable profit given the “showrooming demand function”. The following may happen:
O’s variable profit
O prefers this price
no consumers showroom
some consumers showroom
some consumers showroom
no consumers showroom
∗
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Max RPM
Suppose the supplier sets the wholesale price such that ∗ maximizes O’s variable profit given the “showrooming demand function”. The following may happen:
O’s variable profit
O prefers this price
A price ceiling on O will ensure that O does not “deviate” to a higher price!
some consumers showroom
no consumers showroom
∗
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Summary of analytical results
Channel coordination
• does not deter all showrooming
• requires min (or fixed) RPM on the brick‐and‐mortar seller
• may require max (or fixed) RPM on the online seller, but only if
∗
is close to ∗
Implementation possibility: manufacturer suggested retail price at ∗ , enforced as a price floor at authorized (brick‐and‐mortar) retailers, while acting as an effective price ceiling for online sellers.
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Discussion
• Can other vertical restraints achieve the same goal?
– Exclusive territories not practical here
• Would the supplier want to make showrooming impossible (e.g., by offering different product versions in different channels,…) if this could be achieved costlessly?
– If (at the efficient prices and service level) all consumers who showroom would continue to buy if showrooming were made impossible, then yes.
– If showrooming leads to demand expansion, it depends.
• Charging consumers for service is hard to implement (experience of Australian stores trying to charge for use of fitting rooms).
• Long‐run consequences of allowing lower prices online? Supplier may need to subsidize brick‐and‐mortar showrooms, open stores‐within‐stores,…
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Takeaways
Online retailing increases the scope for free‐riding on services provided by brick‐
and‐mortar stores
‐ The cost of showrooming is low for many consumers.
‐ Pure online retailers, by definition, are unable to provide showrooms.
We show that the best response for suppliers is to impose (minimum or fixed) RPM selectively on those retailers whose service provision needs to be encouraged. Counter to received wisdom, discouraging showrooming altogether, e.g., by imposing a high retail price on the online retailer, is not optimal for the supplier.
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Thank you!
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