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Internet Channel Entry: A Strategic Analysis of Mixed Channel Structures

 

Weon Sang Yoo

Korea University Business School

 

   Despite the rapid growth and exciting potential of emerging marketing channels such as the Internet, finding the best way to utilize them in conjunction with the conventional bricks-and-mortar store channel continues to be a challenge for many firms. For example, Levi Strauss & Co. discontinued its direct Internet channel at http://www.levis.com and http://www.dockers.com and handed online sales over to a few select e-retail partners. In the personal computer market, Gateway closed all of its manufacturer-owned retail stores in 2004 and now distributes its products through its direct Internet channel and independent retailers such as Best Buy and Costco. In contrast, Dell has added its full-scale manufacturer-owned stores to its existing direct Internet channel since the second half of 2006. These anecdotes point to the need for a better understanding of the impact of the introduction of an Internet channel in a variety of mixed channel structures.

 

  This study explores the following questions using the game theoretic approach:

1. When the Internet channel is added to an existing channel system, how does it affect each channel member’s performance and consumer welfare? How is this effect moderated by the specific channel structure before and after the Internet channel launch?

2. What are the key underlying forces that shape the impact of the Internet channel introduction?

3. How do varying market conditions affect the impact of the Internet channel introduction?

 

  By analyzing a game-theoretic model that explicitly captures the store channel and the Internet channel in two different dimensions, this study has investigated how the introduction of an Internet channel affects the channel members and consumers. We have also demonstrated that the impact of an Internet channel introduction not only differs from the impact of a physical store entry but also varies considerably across channel structures and market conditions. Out of the complex results, we have identified five key strategic forces that shape the overall impact of the Internet channel introduction. They are double marginalization effect, market coverage effect, retailer competition effect, price discrimination effect, and myopic inter-channel price coordination effect. Each of the five underlying forces is intuitively appealing, but in combination, they can produce unexpected results under certain conditions. For instance, we find that the addition of an Internet channel does not always lead to lower prices and enhanced consumer welfare, that an existing physical store retailer might react to the competitive entry of the Internet channel by raising its price, and that a horizontally integrated mixed channel retailer might be worse off with inter-channel coordination in pricing.

  For marketing managers, this study highlights the key moderating role of channel structure and market environment on the impact of the Internet channel entry. Since the impact can vary substantially depending on whether it is introduced by the manufacturer, the existing retailer, or a new independent e-tailer, the key strategic question is not only whether to introduce an Internet channel but also how. In addition, it will be critical for manufacturers to discern the relationship between market conditions and the strategic role of each channel (e.g., a mass market channel versus a niche channel). Similarly, retailers facing new competition from an Internet channel will have to strategically decide whether to try to maintain its market share, settle for an even split of the market, or substantially narrow its target market scope to remain profitable.

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