new product design under channel acceptance: brick-and ... · with traditional brick-and-mortar...

New Product Design under Channel Acceptance:Brick-and-Mortar, Online-Exclusive, or Brick-and-Click

Lan LuoMarshall School of Business, University of Southern California, Los Angeles, CA 90089, USA, [email protected]

Jiong SunDepartment of Consumer Science, Purdue University, West Lafayette, IN 47907, USA, [email protected]

I n recent years, an increasing number of brick-and-mortar retailers have entered into the new brick-and-click era.Within this context, when a manufacturer presents a new product offering to a retailer, the ultimate decision is often

made by the retailer regarding (1) whether to carry the new product, and (2) the channel outlet the product will be car-ried in (i.e., in-store only, online-exclusive, or brick-and-click). In response to this trend, we examine how a manufacturermay use product design to influence a dual-channel retailer’s outlet designation decision. This is the first study to investi-gate a manufacturer’s optimal product design strategy when a brick-and-mortar retailer expands online. We demonstratethat, to induce the retailer to carry a new product both offline and online, it may not always be optimal for the manufac-turer to enhance product quality (compared with when the retailer only operates offline). With the online store addition,the retailer may also be incentivized to adjust his participation criterion to a level less than what is determined by his out-side option.

Key words: marketing; new product design; multi-channel retailer; supply chain; game theoryHistory: Received: June 2014; Accepted: April 2016 by Amiya Chakravarty, after 2 revisions.

1. Introduction

In recent years, an increasing number of traditionalbrick-and-mortar retailers (e.g., Home Depot, Toys RUs) have transitioned into the new brick-and-click erato further expand their storefront as well as their cus-tomer bases (e.g., IBISWorld 2011a, Manhanttan Asso-ciates 2010, Hoover’s Company’s Report on Target,Wal-Mart, and Home Depot 2015). With the emergingtrend of brick-and-mortar retailers opening onlinebusinesses, new product manufacturers often do notcontrol whether a new product offering will beaccepted, nor the channel outlet the product will becarried in (in-store only, online-exclusive, or brick-and-click). Instead, the retailer often makes ultimatedecisions regarding whether to stock the new productand how the product will be sold to the consumer.This occurrence is widespread in numerous markets,such as toys, power tools, and apparel. In response tothis trend, manufacturers have also started to takeretailers’ online storefront into consideration in theirproduct planning (Retailing Today 2011, WarehouseClub Focus 2011).With traditional brick-and-mortar retailers entering

into the new brick-and-click era, we observe thatmanufacturers respond differently by trying toeither enhance or lower the quality of their new pro-duct offerings. For example, MagnoGrip produces

magnetized accessories (e.g., wristbands that holdnails and screws) that are currently designated as“online-exclusive" by Home Depot. In an interviewwith the San Francisco Business Times (2009), theowner of MagnoGrip discussed how the companywould strive hard to enhance the quality of its pro-duct offerings so that they would eventually beaccepted into Home Depot’s physical stores. In con-trast, historically Tiffany & Co. was renowned foronly accepting high-end non-jewelry accessories (e.g.,sterling goods, small leather items) from third-partymanufacturers. Nevertheless, ever since the upscaleretailer established its online business, a number ofless-expensive, lower-quality offerings from thesemanufacturers have been added in Tiffany’s brick-and-click store (Tiffany & Company: A Case Study,Blackburn 2004, Jewelry Stores in the US, IBISWorld,2011b).While we observe manufacturers’ efforts to either

increase or lower product quality when a brick-and-mortar retailer opens an online business, no extantresearch has formally examined a manufacturer’soptimal product design strategy when such a retailerexpands online. Although the driving forces behindmanufacturers’ quality choices could be multi-facetedin practice, the primary emphasis of this study is toexamine how a manufacturer may use product designto influence a dual-channel retailer’s channel outlet

2014

Vol. 25, No. 12, December 2016, pp. 2014–2034 DOI 10.1111/poms.12587ISSN 1059-1478|EISSN 1937-5956|16|2512|2014 © 2016 Production and Operations Management Society

designation decision. This is the first study to investi-gate a manufacturer’s (her) new product design strat-egy when a brick-and-mortar retailer (he) expandsonline. We also investigate how the profits of themanufacturer and the retailer are affected by the lat-ter’s decision to operate in dual channels.Within our context, the key considerations faced by

the manufacturer are as follows: First, the manufac-turer must ensure that the retailer is willing to partici-pate in the trade. In today’s marketplace, retailersoften serve as gatekeepers of new product introduc-tions (e.g., Luo et al. 2007, Wall Street Journal 2005).As a result, when designing the new product, themanufacturer must take into account the opportunitycost incurred by the retailer when the latter decides tostock the new product. In the literature, the retailer’sparticipation criterion is often operationalized suchthat the retailer will only stock a new product if heexpects to earn at least a minimum profit (e.g., Anu-pindi and Bassok 1999, Desai 2000, and Luo et al.2007).1 Such a profit threshold mainly reflects theretailer’s opportunity cost of accepting an alternativeproduct into his store (i.e., his outside option). Recog-nizing the retailer’s participation criterion is particu-larly useful in our context, because the retailer’sopportunity cost of allocating his highly constrainedphysical shelf space to a new product is likely to beconsiderably higher than that of allocating virtualshelf space.2 Such a difference in turn affects the man-ufacturer’s new product design strategy when work-ing with a dual-channel retailer.Second, the manufacturer faces the following trade-

offs when deciding whether to design the new pro-duct to target the retailer’s offline or online store. Ifthe retailer decides to carry the new product in-store,the manufacturer will enjoy the physical display ofher new product. However, in such cases, the manu-facturer must satisfy the retailer’s greater participa-tion criterion, which may potentially hinder themanufacturer’s profit. In contrast, if the new productis carried as an online-exclusive, consumers will notbe able to physically inspect the product prior to pro-duct purchase. Such a drawback is particularly salientwhen the touch-and-feel of the new product plays anintegral role in consumers’ purchase decision, forinstances, in product categories such as apparel, jew-elry, accessories, furniture, home decor, and so on(Wankhade and Dabade 2010). Forrester Research(2008) notes that “most consumers still prefer stores. . .by shopping in stores, consumers can touch and feelitems [and] avoid issues surrounding returns." Thisfinding was also supported by Jupiter Research (For-rester Research 2009) and a consumer survey byPriceGrabber.com (Ofek et al. 2011). Because ofunlimited shelf space in the retailer’s online store,however, it is also relatively easier for the

manufacturer to satisfy the retailer’s participation cri-terion. Additionally, as the online storefront extendsthe market to consumers with no easy access to theretailer’s brick-and-mortar store and offers additionalbenefits such as added convenience, greater time sav-ings, and lower search cost (Lal and Sarvary 1999),the manufacturer has the potential to exploit suchbenefits and become more profitable by positioningher product for the retailer’s online store.

1.1. Key FindingsWe develop a game-theoretic model to capture theabove tradeoffs faced by the new product manufac-turer. Our key findings are summarized below.Interestingly, to induce the retailer to carry a new

product both offline and online, it may not always beoptimal for the manufacturer to enhance productquality (compared with when the retailer only oper-ates offline). In particular, when the online storefrontis relatively less appealing for the retailer, for exam-ple, in product categories such as apparel and acces-sories where the lack of physical inspection is ofmajor concern and the benefits of online shopping arerelatively small, the manufacturer may strategicallylower the quality of her new product (may even belower than the optimal quality level in the online-exclusive option) so that the retailer will opt to makethe product available in both channels. In contrast, forproduct categories whose online shopping benefitsare ample and/or the lack of touch-and-feel is oftenconsidered less vital by consumers (e.g., appliancesand electronics), the manufacturer may strategicallyenhance product quality to induce the retailer to carryit both offline and online.The above findings stem from the greater probabil-

ity of product mismatch faced by consumers whenpurchasing a newly introduced product online with-out physical inspection. As a result, the discrepancybetween offline and online willingness-to-pay isgreater in magnitude at higher quality levels. Conse-quently, when the touch-and-feel of the new productis crucial (e.g., apparel and accessories), to attractsome consumers to the retailer’s online store, a strate-gic manufacturer will introduce a product of lowerquality to reduce the disutility of online purchase.Therefore, the retailer will find it more profitable tocarry the new product both offling and online (ratheroffline only).In contrast, when online shopping benefits are high

and/or the lack of touch-and-feel is generally consideredless vital by consumers (e.g., appliances and electronics),the manufacturer will increase the quality of her newproduct offering such that it would also be appealing tothe retailer’s offline store. As a result, the retailer will beincentivized to designate the new product to his brick-and-click store (rather than online only).

Luo and Sun: New Product Design for Dual-Channel RetailerProduction and Operations Management 25(12), pp. 2014–2034, © 2016 Production and Operations Management Society 2015

In both cases discussed above, the adjusted qualitylevel of the new product also reduces the potentialmarket cannibalization effect (i.e., margin loss) facedby the retailer and the manufacturer. When the newproduct is carried both offline and online, some con-sumers have the flexibility to purchase it from eitherchannel outlet while others do not. We referred to theformer as switch consumers. Because the retailer can-not price discriminate among consumers within eachchannel outlet, switch consumers may enjoy a posi-tive surplus from purchasing the new product fromwhichever channel outlet that offers them with agreater utility. This positive surplus implies a marginloss, which in turn leads to the cannibalization effect.In product categories where the touch-and-feel of

the new product is crucial for consumers and the ben-efits of online shopping are relatively small (e.g.,apparel and accessories), this positive surplus ofswitch consumers is an increasing function of productquality. In contrast, for product categories with ampleonline shopping benefits and/or whose physicalinspection is less crucial (e.g., appliances and elec-tronics), this positive surplus may decrease with pro-duct quality. As a result, the manufacturer’s qualitychoices in both scenarios also align with reduced mar-ket cannibalization.We also find that, with the addition of the online

store, the retailer gains additional leverage and mayobtain a profit greater than (rather than equal to) hisopportunity cost of carrying an alternative product ineach respective channel. The retailer receives such anextra surplus when the brick-and-click optionemerges in equilibrium, which arises at intermediatevalues of the offline-participation criterion. And theretailer receives the most surplus, may even be themost profitable, at the tipping point where the brick-and-click option is just slightly more attractive forhim than the online-exclusive option. At this point,the manufacturer must make the utmost adjustmentin her product offering to induce the retailer to carrythe product both offline and online. As a result, theretailer may be incentivized to adjust his participationcriterion to a level less than what is determined by hisoutside option.

1.2. Related LiteratureThis study relates to a broad literature on how firmsshould optimally design their new products in a widevariety of contexts, such as consumer self-selection(Moorthy 1984), differential cost structure (Tyagi2000), product cannibalization (Desai 2001), market-ing-manufacturing trade-offs (Desai et al. 2001), net-work externality (Sun et al. 2004), heterogeneousbuyer search costs (Kuksov 2004), uncertain demand(Tyagi 2006), reference group comparison (Amaldossand Jain 2010), varying purchase histories (Zhang

2011), endogenous deliberation (Guo and Zhang2012), stringent deadlines (Zhang 2016), and so on.We add to this literature by investigating how a man-ufacturer should design a new product when a brick-and-mortar retailer expands online.Our research also builds upon a second stream of

literature that studies manufacturer-retailer interac-tions in a distribution channel. For example, Jeulandand Shugan (1983) and Iyer (1998) have studied howa manufacturer can induce a retailer to offer the levelof service and/or price that is also desired by themanufacturer. Tyagi (1999) examines how a retailerresponds to a manufacturer’s trade deals. Morerecently, with the emerging power of retailers inmany product markets, several researchers havestarted to emphasize the retailer’s critical role in themanufacturer’s product design strategy within thecontext of a single-channel retailer (e.g., Luo 2011,Luo et al. 2007, Villas-Boas 1998, and Williams et al.2011). We extend this line of research by providingthe first formal analysis to examine how a manufac-turer can strategically use product design to influencea dual-channel retailer’s channel outlet designationdecisions.Lastly, this research can be linked to the literature

that explores the market impact of online store adop-tion. From the perspective of the manufacturer, sev-eral researchers have examined a manufacturer’sdecision to complement its traditional channel with adirect channel, for example, an online store (e.g., Cai2010, Cattani et al. 2006, Chen et al. 2008, Chianget al. 2003, Kumar and Ruan 2006, Mukhopadhyayet al. 2008, Ryan et al. 2012, Tsay and Agrawal 2004).From the perspective of the retailer, researchers havestudied whether a brick-and-mortar retailer shouldadopt a dual-channel strategy (e.g., Bernstein et al.2008, Liu et al. 2006, Zhang 2009), and how the retai-ler’s online-store addition affects his strategies suchas pricing and in-store service (e.g., Ofek et al. 2011).We extend this literature by investigating how theonline store addition of the retailer impacts the manu-facturer’s new product design decisions.

2. Model Setup

In this section we construct a stylized model to parsi-moniously illustrate the key trade-offs faced by thenew product manufacturer. In Section 4, we will relaxa set of assumptions made here and discuss implica-tions from several modifications and extensions to themain model.In practice, not all consumers live within the geo-

graphical proximity of retailer’s physical stores. Forsimplicity, we assume that consumers of proportion ahave access to the retailer’s offline store, and theremaining consumers do not have such access. To

Luo and Sun: New Product Design for Dual-Channel Retailer2016 Production and Operations Management 25(12), pp. 2014–2034, © 2016 Production and Operations Management Society

capture the potential additional reach of the retailerwith his online store addition, we follow Ofek et al.(2011) by assuming that all consumers have access tothe retailer’s online store.When the new product is carried as online-exclu-

sive, consumers are unable to touch and feel the pro-duct when making a purchase decision. The lack ofphysical inspection is the primary concern of mostconsumers with online shopping in many product cat-egories, such as apparel, jewelry, accessories, furniture,home decor, and so on (e.g., Forrester Research 2008,2009). Therefore, compared to those who purchase thenew product from the retailer’s offline store, onlineconsumers face a greater probability of product mis-match due to the lack of physical inspection. In linewith Chiang et al. (2003), Shin (2007), Bernstein et al.(2008), and Wankhade and Dabade (2010), we concep-tualize the disutility of online purchases as a probabil-ity of product mismatch due to consumer’s inability totouch and feel the new product. Therefore, consumers’willingness-to-pay associated with purchasing a newproduct online is characterized as dq (0 < d < 1), withq being the intrinsic value of the product. Chiang et al.(2003) also provides empirical evidence that the valueof the parameter d varies by product category, rangingfrom 0.769 for shoes to 0.904 for books.3

Because the empirical results in Chiang et al. (2003)were collected back in 2003, we carried out an inde-pendent empirical study to elicit consumers’ willing-ness-to-pay for purchasing a newly introducedproduct from a traditional vs. a web store (see detailsin Appendix S1). Our survey comprises a variety ofproduct categories including apparel, consumer elec-tronics, furniture, home appliances, jewelry, andbooks. We discover that consumers’ willingness-to-pay for a newly launched product online withouttouch-and-feel is 70.46% of its offline equivalent forapparel, 85.33% for consumer electronics, 72.97% forfurniture, 81.30% for home appliances, 73.78% forjewelry, and 87.17% for books. Consistent with Chi-ang et al. (2003), Bernstein et al. (2008), and the setupin our model, our empirical study further reveals thatconsumers’ willingness-to-pay for a newly introducedproduct online without physical inspection is propor-tional to the intrinsic value of the product (rather thanequivalent to the product’s intrinsic value minus afixed disutility term as proposed in some priorresearch).We further account for the fact that consumers may

differ in their online shopping skills (i.e., some con-sumers are more skillful than others in alleviating theprobability of product mismatch without physicallyevaluating the product), which in turn results in con-sumers’ heterogeneous susceptibility towards buyinga new product online. For instance, certain consumersmay possess greater expertise in the product category

and/or have abundant experience with online shop-ping, and hence are less susceptible to the disutilityassociated with online purchases. Let’s assume thatconsumers of proportion b are more skillful in thisregard and hence attach less disutility (i.e., obtainingutility dhq) towards online purchase. And consumersof proportion 1 � b are less skillful in this respect,and hence attach dlq (with 0\ dl \ dh \ 1) towardsonline purchase.Additionally, as compared to offline shopping,

online purchases offer some unique benefits to con-sumers, such as added convenience, greater time sav-ings, and lower search costs (e.g., Bhatnagar et al.2000, Devaraj et al. 2002, Lal and Sarvary 1999).Accordingly, we denote an online shopping benefit ofs > 0 when consumers purchase the product online.Therefore, parameters d and s illustrate how thedrawback-benefit tradeoff of online purchasingaffects the endogenized product quality decisionmade by the manufacturer. For example, when q issufficiently low, dq + s may be greater than q suchthat purchasing the new product online becomes amore attractive option for some consumers. As illus-trated later, this role of product quality in such atrade-off leads to strategic interactions between themanufacturer’s product quality decision and the retai-ler’s channel outlet choice.4

In Table 1, we summarize the four consumer typesalong with each type’s proportion and its utility ofoffline and online purchases. The total market size isnormalized to unity. We also assume that consumerheterogeneity with respect to online shopping skills ishigh enough, that is, dh [ dl=b, such that (1) servingonly the more-online-skilled segment and (2) servingless- and more-online-skilled segments are both likelyto arise in equilibrium. Furthermore, as online shop-ping accounts for less than 10% of all U.S. shopping(U.S. Census Bureau News 2015), we assume thatthere are more offline shoppers than consumers whoare more skilful in online shopping, that is, a > b.Following Desai (2000), Anupindi and Bassok

(1999), and Luo et al. (2007), the retailer’s participa-tion criterion is operationalized as a minimum profit

Table 1 Consumer Types and Utilities of Offline ðU1Þ and OnlinePurchaseðU2Þ

Consumer type Proportion U1 U2

More-online-skilled,offline-accessible

ab q � p dhq þ s � p

Less-online-skilled,offline-accessible

a(1 � b) q � p dl q þ s � p

More-online-skilled,offline-inaccessible

(1 � a)b / dhq þ s � p

Less-online-skilled,offline-inaccessible

(1 � a)(1 � b) / dl q þ s � p


threshold that is exogenously given and known to themanufacturer. As discussed in Luo et al. (2007),because retailers today often face numerous new pro-duct offerings, the use of an exogenously given mini-mum profit threshold is likely to be many retailers’most effective way of deciding whether to accept orreject a new product. Additionally, given that manu-facturers and retailers operating in such markets oftenhave ongoing relationships, this profit threshold isusually known to the manufacturer.Let us denote the retailer’s participation criterion

for his offline and online stores as R and r, respec-tively, with R > r, because the retailer’s opportunitycost of adding a new product to his highly con-strained physical store is likely to be considerablyhigher than that of carrying the new productonline. We further denote the retailer’s profit fromthe new product when carrying it offline as pr1,online as pr2, and both offline and online as pr3. Bymaximizing his profit from these three options andensuring the participation criterion, that is,maxðpr1 þ r; pr2 þ R; pr3Þ � R þ r, the retailer deter-mines whether and where to carry the new prod-uct. Our rationale for the retailer’s channel outletdesignation rule is that, when carrying the newproduct in one channel outlet only, the retailer canmake at least his corresponding participation crite-rion by carrying an alternative product in the otheroutlet. This is consistent with Bernstein and Marx(2010) as well as our definition of the retailer’s par-ticipation criteria. The manufacturer’s unit cost ofproducing the product, cðqÞ ¼ cq2, is specified as aconvex, increasing function of product quality, q.The game proceeds as follows: The manufacturer

decides the quality (q) and the wholesale price (w) ofthe new product, taking into account the retailer’sparticipation criteria for his offline and online stores.Conditional on the new product’s quality (q) andwholesale price (w), the retailer maximizes his profitby deciding whether to accept the product and, if so,the choice of the channel outlet, as well as the corre-sponding retail price (p).

3. The Analysis

In this section, we present analysis and results fromthe main model. All results presented here areobtained analytically and proofs are provided inAppendix S2. The formal expressions of equilibriumquality, price, and profits in all lemmas and proposi-tions can also be found in Appendix S2.

3.1. Brick-and-Mortar Only (Baseline Model)The manufacturer moves first by deciding the qualityq and wholesale price w of the new product to maxi-mize her profit

pmðq;wÞ ¼ ðw� cq2Þ �QðpÞ; ð1Þsubject to the retailer’s participation constraint,prðp; q; wÞ � R.Given the new product offering, the retailer decides

the retail price by maximizing his profit

prðpÞ ¼ ðp� wÞ �QðpÞ; ð2Þ

where the demand Q(p) = a if p ≤ q; 0 otherwise.

LEMMA 1 (EQUILIBRIUM UNDER A BRICK-AND-MORTAR

RETAILER).

(1) The manufacturer designs the new product so thatthe retailer receives just enough profit to be willingto participate in the trade.

(2) The equilibrium product quality, q0 ¼ 12c, is inde-

pendent of the retailer’s participation criterion, R.(3) The channel introduces a new product only when

the retailer’s participation criterion is not too high,that is, R � a

4c.

Lemma 1 suggests that, when operating the off-line store only, the retailer obtains a profit equal tohis participation criterion R (i.e., the retailer’s par-ticipation constraint, pr � R , is always binding). Asthe game leader, the manufacturer exploits theremaining surplus in the distribution channel. Moreimportantly, the manufacturer’s quality choice doesnot vary with the retailer’s participation criterion.When facing a single-channel, brick-and-mortarretailer, as R increases, the manufacturer will adjusther wholesale price (rather than product quality) inorder to satisfy the retailer’s participation criterion.This finding is in line with Munson and Rosenblatt(1999) and Geylani et al. (2007) which suggest that,prior to the brick-and-click era, as the traditionalretailer (such as Home Depot and Wal-Mart)enhances its ability to attract product offerings fromvarious vendors (higher R in our context), manufac-turers typically respond by lowering wholesaleprices to guarantee the retailer’s participation in thetrade.

3.2. Brick-and-Mortar or Online-Exclusive: ASolution to Limited Shelf SpaceIn this subsection, we examine a scenario wherethe retailer designates the new product as eitheroffline- or online-exclusive. This setup enables usto parsimoniously illustrate the fundamental trade-offs faced by the manufacturer and the retailer,without the complication of accounting for marketcannibalization when the product is available bothoffline and online. We will extend our analysis toinclude the brick-and-click option in the subsequentsubsection 3.3.


Under this setup, the manufacturer decides thequality q and wholesale price w of the new product inorder to induce the retailer to carry her product in hisphysical store (denoted I = 1) or as an online-exclusive (denoted I = 2), by maximizing her profit asfollows

pm� ¼ max

pm1 ¼ maxðq;wÞ ðw� cq2Þ �Q1ðpÞ� �

s.t.,pr1 þ r�Rþ rpr1 þ r� pr2 þ R

�pm2 ¼ maxðq;wÞ ðw� cq2Þ �Q2ðpÞ

� �s.t.,

pr2 þ R�Rþ rpr2 þ R� pr1 þ r

�

8>>>>>><>>>>>>:

9>>>>>>=>>>>>>;: ð3Þ

In (3), pm1 is the manufacturer’s maximum profitif the retailer decides to carry her product as anoffline-exclusive. The manufacturer decides theoptimal quality q and wholesale price w of hernew product subject to (1) the retailer’s participa-tion constraint that the retailer’s total profit is nolower than the profit level determined by his out-side options, that is, pr1 þ r � R þ r; and (2) theretailer’s incentive compatibility constraint that theretailer gains more profits by carrying it offlinethan online, that is, pr1 þ r � pr2 þ R. Similarly, pm2is the manufacturer’s maximum profit if the retai-ler carries the new product as online-exclusive. Insuch cases, the manufacturer decides q and w sub-ject to (1) the retailer’s participation constraint,that is, pr2 þ R � R þ r, and (2) the retailer’sincentive compatibility constraint that the retailergains more profit by carrying the new productonline than offline, that is, pr2 þ R � pr1 þ r.Given the quality q and wholesale price w offered

by the manufacturer, the retailer chooses among car-rying the new product as offline-exclusive (I = 1),online-exclusive (I = 2), or not carrying the product atall (I = 0), as well as the optimal retail price p in thecorresponding channel outlet. The retailer maximizeshis profit as follows:

p r�

¼maxðIÞ

pr1 þ r¼maxðpÞ ðp�wÞ �Q1ðpÞþ r½ � if I ¼ 1pr2 þR¼maxðpÞ ðp�wÞ �Q2ðpÞþR½ � if I ¼ 2

Rþ r if I ¼ 0

8<:

9=;:

ð4Þ

When carrying the new product offline, the retai-ler faces the following demand function

Q1ðpÞ ¼ a if p � q0 otherwise

�. His total profit from both

channel outlets in this case equals the sum of pr1and r (with r representing the profit the retailerreceives from carrying an alternative productonline). When the retailer carries the productonline, the demand function is given by

Q2ðpÞ ¼1 if p � dlq þ sb if p 2 ðdlq þ s; dhq þ s�0 otherwise

8<: . His total profit

from both channel outlets in this case equals tothe sum of pr2 and R. When the retailer does notaccept the new product into either channel, hegains a profit equal to his outside options (i.e.,R + r).Compared with the baseline model, the online

store addition introduces an incentive compatibil-ity constraint into the retailer’s considerations,that is, the retailer must decide where to carrythe product (offline-exclusive vs. online-exclusive),in addition to whether to participate in the trade.This poses an additional challenge for the manu-facturer in motivating the retailer to carry thenew product in the channel outlet that is alsodesired by her. The introduction of this incentivecompatibility constraint further entails importantimplications for both the manufacturer and theretailer.The equilibrium outcomes are discussed in

Propositions 1 and 2. Figures 1 and 2 depict howequilibrium quality, wholesale price, and profitschange as a function of the retailer’s offline-participation criterion R (while keeping r constant).5

To illustrate the impact of the retailer’s onlinestore addition, we also include equilibrium out-comes from the baseline model in dotted lines inall figures.

PROPOSITION 1 (EQUILIBRIUM QUALITY IN BRICK-AND-MORTAR VS. ONLINE-EXCLUSIVE).

(1) There exists a critical offline-participation criter-ion, R̂, such that the manufacturer will designthe new product to target the retailer’s offlinestore if R� R̂; online store otherwise.

(2) When R is in an intermediate region, R 2ðR; R̂�, the manufacturer will enhance productquality (compared with when the retailer onlyoperates offline), that is, q� [ q0, to induce theretailer to carry it offline. When R [ R̂, a pro-duct of lower quality, that is, q� ¼ dh

2c ordl2c \ q0, will be introduced to target the retailer’sonline store.

With the addition of the online store, in order toinduce the retailer to carry the new product in thechannel outlet that is also desired by the manufac-turer, the latter is compelled to adjust the quality ofher new product offering when R is not too low. Inparticular, the magnitude of the retailer’s offline-participation criterion R directly impacts the manu-facturer’s equilibrium quality choice. This contraststo the baseline model in which the equilibrium


quality is independent of R. Generally, the equilib-rium quality first (weakly) increases then (weakly)decreases with R.

When R is sufficiently small (i.e., R < R), the manu-facturer will behave the same as if the retailer’s onlinestore were absent, that is, product quality is

(a) (b)

Figure 1 Equilibrium Quality and Wholesale Price as a Function of R. (We use a = 0.8, b = 0.5, dh ¼ 0:95, dl ¼ 0:4, c = 0.35, s = 0.01, andr = 0.02.)

(a) (b)

Figure 2 Equilibrium Profits as a Function of R. (The Parameter Values are the Same as Those in Figure 1.)


independent of R (Figure 1a). With a sufficiently smallopportunity cost (R) of allocating physical shelf spaceto a new product, the option of carrying the new pro-duct online is not attractive to the retailer. Conse-quently, the retailer’s incentive compatibilityconstraint is not active in this region. Therefore, themanufacturer only needs to satisfy the participationcriterion, that is, the profit that the retailer gains fromthe product is at least R, or pr1 þ r � R þ r, is the onlyactive constraint. In this case, the manufacturerbehaves the same as in the baseline model, that is, asif the online store were absent. Namely, to satisfy theretailer’s participation constraint, the manufactureronly reduces the wholesale price (Figure 1b). As inthe baseline model, the retailer gains exactly his par-ticipation criterion R + r in this region, as illustratedin Figure 2b.When R is intermediate, that is, R 2 (R, R] , the

manufacturer is compelled to enhance product qual-ity (q� [ q0). In this region, with increasing R, theincentive compatibility constraint, pr1 þ r � pr2 þ R,comes into play. Namely, the retailer will only allo-cate the new product to his offline store if he deemsthis strategy more profitable than carrying it asonline-exclusive. Unlike wholesale price, productquality has a differential impact on consumers’ off-line vs. online willingness-to-pay. Given that thedisutility of online purchase is proportional to pro-duct quality, consumers may prefer to purchase aproduct offline rather than online when its qualityis sufficiently high. Consequently, a strategic manu-facturer will increase the quality of her new productsuch that the retailer will opt to carry it offline asdesired by the manufacturer. Meanwhile, the manu-facturer is able to compensate for her higher vari-able cost resulting from higher product quality bycharging a higher wholesale price. In this region,both participation and incentive compatibility con-straints are active for the retailer (i.e., the retailerreceives R + r). However, the increase in the whole-sale price does not fully compensate for the increasein the manufacturer’s cost. As a result, the manufac-turer’s profit continues to decrease and is lowerthan her profit in the benchmark model.When the offline-participation criterion reaches

R, further enhancing product quality becomes toocostly for the manufacturer. Therefore, to inducethe retailer to carry the new product offline, themanufacturer will maintain product quality at thehighest possible level while reducing the wholesaleprice. Due to the decreasing wholesale price alongwith high product quality, the retailer obtainsmore than his participation criterion R + r whenR 2 ðR; R̂� as shown in Figure 2b (we will providemore details on the underlying mechanism of thisresult when we discuss Proposition 2). In this

region, while his incentive compatibility constraintis active, the retailer’s participation constraint is nolonger binding, that is, pr1 þ r [ R þ r, that is,pr1 [ R.6

When the offline-participation criterion reaches thetipping point R̂ , inducing the retailer to carry the pro-duct offline is no longer economical for the manufac-turer. Instead, the manufacturer will induce theretailer to carry the product online by choosing aquality lower than that of the baseline model (i.e.,

q� ¼ dh2c or

dl2c \ q0). Given the online shopping benefit

s and a relatively small disutility of purchasing a low-quality product online, consumers find it more desir-able to purchase the new product online than offline(i.e., dhq þ s or dlq þ s [ q). In such cases, the retaileralso finds it more profitable to carry the new productonline.The resulting equilibrium profits stemming from

the strategic interactions between the manufacturerand the retailer are summarized in Proposition 2below.

PROPOSITION 2 (EQUILIBRIUM PROFITS IN BRICK-AND-MORTAR VS. ONLINE-EXCLUSIVE).

(1) When R 2 ðR; R̂�, the retailer obtains more thanhis offline-participation criterion R from carryingthe new product offline.

(2) When R is at the tipping point (i.e., R̂) where theoffline option is just slightly more desirable thanthe online option for the manufacturer, the retailerenjoys the most surplus from carrying the newproduct offline and may even be the mostprofitable.

(3) When R is sufficiently high, the manufacturer alsobecomes better off with the addition of the retailer’sonline store.

In the intermediate region, that is, R 2 ðR; R̂�, theretailer is able to gain more than his offline-partici-pation criterion R from carrying the new productoffline, that is, pr1 [ R. In this region, in order tosatisfy the retailer’s incentive compatibility con-straint, that is, to ensure that the offline option ismore profitable than the online option to the retai-ler, the manufacturer raises her product quality to asufficiently high level such that consumers’ utilityof purchasing the product offline is significantlyhigher than that of purchasing it online. Hence, theretailer is able to price the product high in his off-line store, and consequently obtains more than hisoffline-participation criterion R.Such an effect becomes stronger when the offline-

participation criterion R increases. As R gets larger,the online option becomes more attractive for theretailer. To induce the retailer to allocate the new


product to his offline store, the manufacturer has tofurther decrease wholesale price while keepingquality at the highest possible level. Consequently,the retailer gains the most possible surplus, definedby pr1 � R, at the tipping point R̂ where the offlineoption is just slightly more desirable than the onlineoption for the manufacturer, as shown in Figure 2b.That is, at R̂, the retailer enjoys the most leverage inhis relationship with the manufacturer. Meanwhile,the manufacturer’s profit is lowest at this point. Aninteresting implication from this finding is that, insuch cases, rather than specifying the highest possi-ble R, the retailer may be incentivized to adjust hisparticipation criterion to a level less than what isdetermined by his outside option.When R increases beyond R̂, the retailer’s profit

drops back to his participation criterion, R + r. Addi-tionally, when R is very high, the manufacturer alsobenefits from the retailer’s online store addition. Asshown in the dotted line in Figure 2a, without theretailer’s online store, the manufacturer’s profit isstrictly decreasing in R. With the retailer expandingonline, the manufacturer’s profit (the solid line) willsurpass that in the baseline model (the dotted line)when R is sufficiently high.

3.3. Brick-and-Click, Offline-Exclusive, orOnline-ExclusiveAs the primary focus of this research, we discuss inthis subsection the case where the retailer considersthe following complete set of options for the manufac-turer’s new product: offline-exclusive (I = 1), online-exclusive (I = 2), brick-and-click (denoted I = 3), andnot carrying it in either store (I = 0).Different from subsection 3.2., when the product

is carried both offline and online, some consumers(i.e., switch consumers) can choose between pur-chasing the new product offline or online, depend-ing on from which channel outlet they can obtain ahigher utility. We study how the presence of theseswitch consumers influences the manufacturer’sequilibrium product quality choice, as well as theprofits of the manufacturer and the retailer. Giventhat nearly 80% of multichannel retailers price itemsconsistently across channels (Forrester Research2004, National Retail Federation 2006), we followthe norm in the literature (e.g., Liu et al. 2006, Ofeket al. 2011) by assuming that the retailer sets thesame price for the new product if carrying it bothoffline and online.The game setup is similar to that described in

subsection 3.2, with the exception that the manufac-turer now needs to satisfy two incentive compatibil-ity constraints in maximizing her profit in eachscenario,

max


s.t.,

pr1 þ r�Rþ r

pr1 þ r� pr2 þ R

pr1 þ r� pr3

8><>:


s.t.,

pr2 þ R�Rþ r

pr2 þ R� pr1 þ r

pr2 þ R� pr3

8><>:


s.t.,

pr3 �Rþ r

pr3 � pr1 þ r

pr3 � pr2 þ R

8><>:

8>>>>>>>>>>>>>>>>>>>>>>>>><>>>>>>>>>>>>>>>>>>>>>>>>>:

9>>>>>>>>>>>>>>>>>>>>>>>>>=>>>>>>>>>>>>>>>>>>>>>>>>>;

; ð5Þ

and the retailer maximizes the following profit:

maxðIÞ

pr1 þ r ¼ maxðpÞ ðp�wÞ �Q1ðpÞ þ r½ � if I ¼ 1pr2 þ R ¼ maxðpÞ ðp�wÞ �Q2ðpÞ þ R½ � if I ¼ 2

pr3 ¼ maxðpÞ½ðp�wÞ �Q3ðpÞ� if I ¼ 3Rþ r if I ¼ 0

8>><>>:

9>>=>>;;

ð6Þwhere Q1, Q2, and Q3 are given in Table 2.From the retailer’s perspective, the brick-and-click

option can only be more profitable than the offline-or online-exclusive option if it can attract moredemand at the same price. Hence, the region of par-ticular interest is p 2 ðdlq þ s; p̂�, where the retailerreceives demand a + (1 � a)b, which is higher thanthe respective demand in either the offline-exclusive(with demand a) or online-exclusive option (withdemand b) at the same price (Table 2). Note thatsuch a region is non-empty only when q [ dlq þ s.When choosing the brick-and-click option, the retai-ler will set the retail price at the upper bound of

the region, that is, p� ¼ p̂ ¼ q if q� s1�dh

dhqþ s otherwise

�.

As shown in Table 2, in other regions, the retailerreceives the same demand as in offline-or online-exclusive.Consequently, from the retailer’s perspective, the

brick-and-click option can be a profitable strategywith an intermediate price and an intermediatedemand. In other words, the brick-and-click optionprovides the retailer with an additional lever to fine-tune the volume-margin tradeoff he faces. At thesame time, the brick-and-click option is a potentiallyprofitable strategy for the manufacturer as well,because her quality choice can influence from whichchannel outlet consumers would purchase the newproduct. Table 3 further provides each consumer seg-ment’s channel outlet choice when the product isavailable both offline and online. In this region, the


more-online-skilled, offline-accessible consumers (i.e.,switch consumers) have the flexibility of purchasingthe product either offline with utility q � p or onlinewith utility dhq þ s � p, whichever is greater.Hence, the manufacturer can potentially influence

consumers’ purchase behavior by designing her pro-duct at different quality levels. In other words, thepresence of switch consumers enhances the manufac-turer’s ability to use product quality to influence theretailer’s channel designation choice. We investigatehow such a demand re-direction effect has additionalimplications for the manufacturer’s quality choice, aswell as the manufacturer’s and the retailer’s profits.Figures 3–4 illustrate how the equilibrium quality andprofits change with the retailer’s offline-participationcriterion R.7

PROPOSITION 3 (EQUILIBRIUM QUALITY IN BRICK-AND-CLICK, OFFLINE-EXCLUSIVE, OR ONLINE-EXCLUSIVE).

(1) When R � R̂1, the manufacturer will design thenew product to target the retailer’s offline storeonly; when R 2 ðR̂1; R̂2�, brick-and-click; whenR [ R̂2, online-exclusive.

(2) When dh and/or s is low, in order to induce theretailer to carry the new product in his brick-and-click store, the manufacturer may design a productof lower quality, that is, q� � dh

2c\q0; otherwise, ahigher quality product, that is, q� � q0 ¼ 1

2c maybe introduced.

We obtain the following new insights. First, thebrick-and-click option emerges in equilibrium atintermediate values of R. When R is low or high,the manufacturer finds it more profitable to designthe new product to target the retailer’s offline-

exclusive or online-exclusive options in a fashionsimilar to that described in subsection 3.2. Never-theless, when R is intermediate, the manufacturerobtains the most profit by targeting the retailer’sbrick-and-click store. As a result, compared to sub-section 3.2, the manufacturer must adjust her pro-duct quality in a wider range, along with areduced wholesale price, to incentivize the retailerto carry it in both of his channel outlets. Second,consumers’ dual channel purchase flexibilitystrengthens the manufacturer’s ability to use pro-duct quality (i.e., in a wider range) to influence theretailer’s channel outlet choice. In particular, themanufacturer may strategically lower the quality ofher new product to induce the retailer to carry itboth offline and online.When the online storefront is relatively less appeal-

ing to consumers, that is, dh and/or s is low, (e.g., inproduct categories such as apparel and jewelry), themanufacturer will offer a lower-quality product(maybe even lower than the optimal quality level inthe online-exclusive option), such that the disutility ofpurchasing the new product online is considerablyalleviated. As a percentage of the intrinsic value ofthe product, the disutility of online purchase is smal-ler at lower-quality levels. This in turn may motivatesome consumers to purchase the new product online.As a result, the retailer may be induced to allocate theproduct both offline and online (rather than offlineonly).In this case, market cannibalization, stemming from

switch consumers’ dual channel purchase flexibility,is also reduced at low quality levels. Specifically, ifcarrying the product both offline and online, the retai-ler will have to set the retail price at online con-sumers’ valuation, that is, p ¼ dhq þ s, which islower than offline consumers’ valuation, that is,dhq þ s\ q. Consequently, the switch consumers willobtain a positive surplus (i.e., ð1 � dhÞq � s) by pur-chasing the product offline. This positive surplusimplies a margin loss (i.e., cannibalization). As anincreasing function of q, such a cannibalization effectcan be reduced at low quality levels.Our results described above can be related to Tif-

fany’s non-jewelry accessories example given earlierin our paper. In such categories, the likelihood of

Table 2 Product Demand in Brick-and-Click Vs. Offline-Exclusive Vs. Online-Exclusive

Price region Q1ðpÞ Q2ðpÞ Q3ðpÞ Comparison

If p � dl q þ s a 1 1 Q3 ¼ Q2

If p 2 ðdl q þ s; p̂� a b a + (1 � a)b Q3 [ Q1; Q3 [ Q2

If p 2 ðp̂; dhq þ s� a b b Q3 ¼ Q2

If p 2 ðdhq þ s;max½dhq þ s; q�� a 0 a Q3 ¼ Q1

If p [ max½dhq þ s; q� 0 0 0

where p̂ ¼ min½dhq þ s; max½dl q þ s; q��.

Table 3 Consumer Purchase Behavior under Brick-and-Click

Consumer type p� ¼ q if q � s1�dh

p� ¼ dhq þ s if q [ s1�dh


Purchase online Purchase offline


Purchase offline Purchase offline


Purchase online Purchase online

Less-online-skilled,offline-inaccessible

No purchase No purchase


product mismatch without touch-and-feel is oftenquite high. Therefore, when the offline-participationcriterion is intermediate, a strategic third-party

manufacturer may lower the quality of her productoffering so that Tiffany will opt to carry it both offlineand online (rather than offline only).

(a) (b)

Figure 3 Equilibrium Quality as a Function of R. (We use a = 0.8, b = 0.5, dh ¼ 0:95, dl ¼ 0:4, c = 0.35, s = 0.01 for (a), s = 0.08 for (b) andr = 0.02.)

(a) (b)

Figure 4 Equilibrium Profits as a Function of R When dh and/or s is High. (We Omit Figures When dh and/or s is Low due to Similarity. TheParameter Values are the Same as Those in Figure 3a.)


In contrast, when the online storefront is relativelymore appealing to the consumer, that is, dh and/or sis high, (e.g., in product categories such as appliancesand electronics), the manufacturer is compelled todesign a product of higher quality (compared to thebaseline model) in order to enhance the relative bene-fit of inspecting the new product in-store so that theretailer will not opt for the online-exclusive option.Recall that the relative benefit of physical inspection(i.e., the discrepancy in consumer’s offline and onlinewillingness-to-pay) is greater for higher quality prod-ucts. In such cases, offline consumers’ product valua-tion (q) is lower than that of online consumers(dhq þ s). As a result, the market cannibalizationeffect (i.e., switch consumers’ positive surplus,s � ð1 � dhÞq, via purchasing the product online) isreduced at higher product quality levels.Relating to the magnetized accessories example

from MagnoGrip discussed earlier in our paper,because the specifications and functions of such prod-ucts are more-or-less self explanatory, the lack oftouch and feel may not be a central concern for someconsumers. Consequently, at intermediate values ofR, the manufacturer may enhance the quality of theseproducts to induce the retailer to carry them both off-line and online (rather than online only).

PROPOSITION 4 (EQUILIBRIUM PROFITS IN BRICK-AND-CLICK, OFFLINE-EXCLUSIVE, OR ONLINE-EXCLUSIVE).

(1) When the new product is carried both offline andonline, the retailer receives strictly more thanR + r.

(2) At the tipping point where the brick-and-clickoption is just slightly more profitable for the man-ufacturer than the online-exclusive option, theretailer receives the most surplus and may even bethe most profitable.

At the intermediate region of R, that is,R 2 ðR̂1; R̂2�, when the product is carried both offlineand online, in either case discussed above (Figure 3aor b), the retailer always receives more than R + r(Figure 4b). In this region, the manufacturer mustensure that the retailer receives more profit by carry-ing her product in his brick-and-click store ratherthan offline-exclusive or online-exclusive. The manu-facturer is able to meet this requirement by adjustingher product quality as well as offering a low whole-sale price (See Figure B1 in Appendix S2). Conse-quently, the retailer receives strictly more than R + runder the brick-and-click option. When dh and/or s islow, the majority of the retailer’s surplus originatesfrom his offline store; online store otherwise. As Rapproaches R̂2, with an increasing opportunity cost ofstocking the new product offline, the online-exclusiveoption becomes more attractive for the retailer. As a

result, the manufacturer has to forego more profit tosatisfy the retailer’s incentive compatibility constraint.Consequently, the retailer receives the most surplusat the tipping point R̂2.

4. Model Extensions

In this section, we relax a set of assumptions made inthe main model. Such extensions enable us to derivefurther insights into a strategic manufacturer’s newproduct design decision when a brick-and-mortarretailer expands online. All detailed analyses of theextensions can be found in Appendix S2.

4.1. Manufacturer Charging Different WholesalePrices Offline and OnlineIn this extension, we consider a case where the manu-facturer charges different wholesale prices for sellingthe new product offline and online. Let us denote theoffline and online wholesale prices by w1 and w2,respectively. The following Lemma 2 summarizes ourresults when the product is carried both offline andonline. The new equilibrium quality and wholesaleprices in the brick-and-click region are depicted inFigures 5–6, with results from the main modeldenoted in dash lines and those from this extension insolid lines. When the product is carried offline- oronline-exclusive, our results remain the same as in themain model.

LEMMA 2 (DIFFERENT WHOLESALE PRICES OFFLINE AND

ONLINE). In the case of brick-and-click,

(1) The manufacturer’s quality decisions remain quali-tatively the same as in the main model.

(2) With different wholesale prices offline and online,the manufacturer does not need to adjust her qual-ity to the same extent as in the main model. Whendh and/or s is low, the equilibrium quality ishigher than that in the main model, but is stilllower than that in the baseline model. When dhand/or s is high, the equilibrium quality is lowerthan that in the main model, but is still higherthan that in the baseline case.

(3) With increasing R, the manufacturer first offers alower online wholesale price than offline, then alower offline wholesale price than online.

When offering different wholesale prices offlineand online, the manufacturer enjoys a greater lever-age in inducing the retailer to carry the new productin his brick-and-click store. Consequently, while herquality decisions remain qualitatively the same asbefore, the manufacturer does not need to adjust pro-duct quality to the same extent as in the main model.In the brick-and-click region, at low values of R, themanufacturer offers a lower wholesale price online


than offline (i.e., w�2 \w�

1). At low values of R, carry-ing the product as offline-exclusive is highly attractiveto the retailer. To induce the retailer to carry the

product in his brick-and-click store rather than offlinestore only, the manufacturer strategically charges alower wholesale price online to make the product

(a) (b)

Figure 5 Equilibrium Quality as a Function of R When Manufacturer Can Charge Two Wholesale Prices (The Parameter Values are the Same asThose in Figure 3.)

(a) (b)

Figure 6 Equilibrium Wholesale Prices as a Function of R When Manufacturer Can Charge Two Wholesale Prices. (The Parameter Values are theSame as Those in Figure 3.)


relativley more attractive for the retailer’s onlinestore. Similarly, because the retailer finds the online-exclusive option highly attractive at high values of R,the manufacturer opts to charge a lower price offlineto enhance its attractiveness of the offline store so thatthe retailer will carry the product as brick-and-clickrather than online-exclusive. Intuitively, the manufac-turer’s profit increases and the retailer’s profitdecreases as compared with the main model. Never-theless, the retailer still gains more than R + r in theintermediate region of R as in the main model.

4.2. Retailer Charging Different Retail PricesOffline and OnlineWe now examine whether our main insights hold ifthe retailer is able to charge different retail prices forthe new product offline and online. Let us denote theoffline and online prices by p1 and p2, respectively. Inthis case, the retailer has two possible pricing strate-gies and all other cases are dominated by eitherthe online-exclusive or the offline-exclusive option.The two possible pricing strategies are as follows:(1) charging p1 ¼ q to offline buyers, and p2 ¼ dhq þ sto online buyers, in which case all consumers buyexcept for the less-online-skilled, offline-inaccessibleconsumers of size (1 � a)(1 � b); and (2) chargingp1 ¼ q to offline buyers, and p2 ¼ dlq þ s to onlinebuyers, in which case all consumers buy. As shown inAppendix S2, compared with strategy (2), the retailerunder strategy (1) gains less demand but a higherprofit margin. Hence, given (q, w), the retailer chooses(1) over (2) when dh or q is sufficiently high (such thatp2 is sufficiently high), that is, when the profit marginis sufficiently higher than that in (2). This in turn com-pels the manufacturer to design a high quality pro-duct in order to induce the retailer to opt for strategy(1); low quality otherwise. Therefore, our key insightsstill hold, that is, when dh is high enough, the manu-facturer will introduce a high quality product to tar-get the retailer’s brick-and-click store; low qualityotherwise. Note that under strategy (1), the cannibal-ization effect goes away. Under the second strategy,the cannibalization effect still exists because the more-online-skilled, offline-accessible consumers obtain apositive surplus, ðdh � dlÞq, by purchasing the pro-duct online.

4.3. Retailer Dictating Wholesale PriceIn this extension, we analyze a scenario where theretailer dictates wholesale price. Under this setup, theretailer will set the wholesale price, w, slightly abovethe manufacturer’s cost, that is, cq2, such that themanufacturer gains no profit.In such cases, the manufacturer’s ability to use pro-

duct design to influence the retailer’s channel outletdesignation decision is vastly reduced. Because the

retailer sets the wholesale price w ¼ cq2 regardless ofR, the optimal quality is independent of R in all cases.Hence, the retailer’s total profit is independent of R inthe brick-and-click and offline-exclusive cases. In thecase of online-exclusive, the retailer’s profit is in-creasing in R because his total profit equals hisonline profit plus R. Therefore, the retailer willcarry the product as brick-and-click or offline-exclusive when R is low; online-exclusive when R ishigh. This contrasts to findings from our mainmodel where the manufacturer is able to adjust herproduct quality to motivate the retailer to carry theproduct as offline-exclusive, online-exclusive, orbrick-and-click when R varies.In practice, the degree to which the focal retailer is

involved in setting wholesale prices varies from mar-ket to market. For example, Wal-Mart is known fordictating wholesale prices and other terms of the con-tract (PBS Frontline 2004). In such cases, the key find-ings from our main model do not apply. Meanwhile,our conversations with industry executives alsoreveal that the price setting scheme in our main modelis applicable to a large number of industry practices(such as the relationship between Stanley Black &Decker and Home Depot; and that between Matteland Toys R Us). In such cases, the relative power ofthe two firms is not as extreme as in the case of Wal-Mart.Consequently, our conjecture is that the manufac-

turer’s ability to use product quality to influence theretailer’s channel outlet designation decision is posi-tively associated with her relative power in the distri-bution channel. With a notable exception of Wal-Mart, when the retailer does not dictate wholesaleprice, manufacturers may greatly enhance the successof her new product introduction by taking intoaccount the former’s channel outlet designationdecisions in her product design decisions.

4.4. Two Different Qualities Intended for TwoDifferent ChannelsIn this extension, we analyze a scenario where themanufacturer offers two products with quality levels,q1 and q2, with q2 \ q1 (along with two wholesaleprice, w1 and w2, with w2 \w1Þ, intended for the twodifferent store fronts of the dual channel retailer.Given the overall complexity of this model setup, welimit our attention to the focal manufacturer’s qualitychoices around the tipping points where her beststrategy is to switch from offering a single product(targeting either the offline or online store of the retai-ler) to offering two different qualities intended for thetwo different channels. We emphasize our analysis tosuch regions because, with attempts to incentivize theretailer to carry the product(s) in the channel outlet(s)also desired by the manufacturer, the latter often has


incentives to considerably adjust the quality level ofher product offering(s) around such tipping points.We discover that, in such cases, the high quality

product is intended for the offline channel and thelow quality product is intended for the online chan-nel. The manufacturer mainly uses the lower qualityproduct (q�1 ¼ 1

2c) as a lever to influence whether theretailer will accept both products or only one productoffering. Specifically, the manufacturer offers (1) a rel-atively high online quality (q�2 ¼ dh

2c) when dh and/or sis high; and (2) a relatively low online quality (q�2 ¼ dl

2cor dl

2c � ðdh � dlÞacð1� aÞ ) when dh and/or s is medium or low.

From the retailer’s perspective, one key benefit ofthe brick-and-click option is that he can sell the prod-ucts to both offline and online consumers (as com-pared to the cases of offline- or online- exclusive).Nevertheless, as illustrated earlier, one potentialcaveat of the brick-and-click option is that some con-sumers may obtain a positive surplus given their flex-ibility of choosing which channel to make a purchase.As a result, the dual-channel retailer may face apotential market cannibalization effect.When the online storefront is relatively more

appealing to the consumer (i.e., dh and/or s is high),the manufacturer needs to ensure that the retailer willopt to the brick-and-click option rather than theonline-exclusive option. Under this scenario, by offer-ing a relatively high quality product online (q�2 ¼ dh

2c),the two product offerings from the manufacturer caneliminate the potential market cannibalization associ-ated with the brick-and-click option. Therefore, withthe combination of selling to more consumers and nomarket cannibalization effect, the retailer enjoys agreater profit from selling two different versions ofthe product in the two channels than selling only oneproduct online. In this case, the switch consumers areindifferent in purchasing either the online or the off-line product. And because the retailer charges a rela-tively high retail price for the online product, themarket is not fully covered (the less-online-skilled,offline inaccessible consumers opt to no purchase).In contrast, when the online channel is relatively

less attractive for the consumer (i.e., dh and/or s ismedium or low), the manufacturer needs to incen-tivize the retailer to choose the brick-and-click optionrather than the offline-only option. In this scenario,two subcases arise. When dh and/or s is medium, themanufacturer reduces the online product quality to dl

2c.And the retailer finds it most profitable to carry bothproducts by charging a low online price (while keep-ing the offline price the same as in the offline-exclusive option). In this case, switch consumers optto purchase the online product. When dh and/or s islow, the manufacturer further reduces the online pro-duct quality to dl

2c � ðdh�dlÞacð1�aÞ . In this case, the retailer

also reduces the retail price of the offline product such

that the switch consumers are indifferent in purchas-ing either product. In both subcases, the switchconsumers enjoy a positive surplus. Nevertheless,because the market is fully covered in both subcases,the retailer enjoys the utmost market expansion effectunder the brick-and-click option. Overall, the marketexpansion effect dominates the market cannibaliza-tion effect. Therefore, the retailer still gains moreprofit by selling product q1 offline and product q2online, rather than selling only one product offline.To summarize, when offering two different quality

levels intended for retailer’s two different channels,the manufacturer will strategically adjust the qualitylevel of the low quality product such that the brick-and-click option becomes more attractive to the retai-ler than the alternative options. Similar in spirit to themain model, the optimal quality level of the low qual-ity product depends on the relative attractiveness ofthe online storefront to the consumer (i.e., the valuesof dh and/or s). A relatively high quality will beoffered online when dh and/or s is high; low onlinequality otherwise.

4.5. Two-Part Tariff Supply ContractWe now consider a scenario where the manufactureradopts a two-part tariff pricing scheme, that is, a per-unit wholesale price and a fixed fee. The fixed feeserves to allocate profits between the manufacturerand the retailer (Cachon and Lariviere 2005). Beingthe first mover, the manufacturer is able to charge afixed fee such that the retailer never makes more thanhis participation criteria, R + r. Such a fixed fee, how-ever, does not affect the equilibrium quality that themanufacturer chooses in order to influence the rela-tive attractiveness of the two channel outlets to theretailer. This is reflected in the retailer’s best responsefunction, as specified in Appendix S2, in choosingwhich channel outlet to carry the product. Becausethe fixed fee does not interact with product quality inthe retailer’s best response function or the manufac-turer’s profit function (i.e., it drops out of the FOCs),the equilibrium quality will remain qualitatively thesame as in the main model. In this case, the fixed feefully absorbs the retailer’s extra surplus.

4.6. Retailer’s Endogenous Participation CriterionIn this extension, we account for the possibility of anendogenous retailer participation criterion. In suchcases, the retailer is subject to a maximum possibleparticipation criterion, Rmax which is determined byhis outside option. When Rmax is sufficiently low orhigh, the retailer will set his participation criterion atthe maximum possible level. Nevertheless, whenRmax is intermediate, the retailer may be better-off byadjusting his participation criterion to a level lowerthan Rmax.


An examination of the retailer’s profit in Figure 4bexplains the rationale. When Rmax falls in the region tothe immediate right of R̂2, it is obvious that a strategicretailer will set his participation criterion at the tippingpoint R̂2 rather than at Rmax; because the retailer willgain more profit at R̂2 than at Rmax. In contrast, theretailer will set his participation criterion at Rmax when(1) Rmax \ R̂2, or (2) when Rmax [ R̂2 and Rmax is suffi-ciently high such that the profit achieved at Rmax isgreater than that at R̂2 . The role of rmax is similar.Consequently, the intermediate region where the

retailer carries the product both offline and online willenlarge. Specifically, the upper bound of the region(R̂2 in Figure 4b) will extend to the right because theretailer will set his participation criterion at the tip-ping point R̂2 when Rmax falls in the region to theimmediate right of R̂2. It is also worth noting thatthe equilibrium quality level remains the same as inthe main model, because the retailer’s endogenousparticipation criterion does not affect the basic pre-mises of the manufacturer’s profit maximization.

4.7. Only a Portion of Consumers Having Accessto the Retailer’s Online StoreIn this extension, we relax the assumption that all con-sumers have access to the retailer’s online store.Instead, only consumers of proportion c have onlineaccess. Among these individuals, consumers of pro-portion b are more skilled online shoppers and theothers are less skillful. As in the main model, con-sumers of proportion a have access to the retailer’soffline store. We then have six types of consumers aslisted in Table 4.Under this setup, the equilibrium quality in the case

of brick-and-click remains qualitatively the same as inthe main model, that is, the manufacturer decreasesproduct quality when dh and/or s is low (increasesotherwise) in order to induce the retailer to designatethe new product to both channels. Nevertheless,because the retailer’s offline store is relatively more

attractive within this context, the manufacturer doesnot need to adjust the product quality to the sameextent as in the main model when inducing the retai-ler to designate the new product to either the offlinechannel or both channels. Specifically, in the case ofbrick-and-click, when dh and/or s is low, the equilib-rium quality is higher than that in the main model,but is still lower than that in the baseline model; whendh and/or s is high, the equilibrium quality is lowerthan that in the main model, but is still higher thanthat in the baseline model. Similarly, in the case of off-line-exclusive, the equilibrium quality is lower thanthat in the main model, but still higher than that inthe baseline model. In the case of online-exclusive, theequilibrium quality remains the same as in the mainmodel.

4.8. Continuous Consumer HeterogeneitiesIn this subsection, we relax the assumption of discreteconsumer segments using models of continuous con-sumer heterogeneity. We first analyze a case whereconsumer heterogeneities are continuous in bothdimensions. In the offline market, consumers are geo-graphically uniformly distributed on a Hotelling lineof unit length. A representative consumer located atx 2 [0, 1] gains utility q � tx � p by purchasing theproduct from the retailer’s offline store located atx = 0, where t is the unit transportation cost. Whenpurchasing the product online, at each locationx 2 [0, 1], a representative consumer d � U½0; dmax�obtains utility dq + s � p by purchasing the productfrom the online store, where dmaxq represents utilityof the most skilled online shoppers.Under this setup, the retailer’s profit from the new

product is given by prðp; q; wÞ ¼ QIðpÞ � ðp � wÞand the manufacturer’s profit is given bypmðp; q; wÞ ¼ QIðpÞ � ðw � cq2Þ, with I = {0, 1, 2, 3}.In the offline-exclusive case, the offline demand isgiven by Q1ðpÞ ¼ q�p

t . In the online-exclusive case, theonline demand is given by Q2ðpÞ ¼ 1 � p�s

qdmax. In the

case of brick-and-click, the demand is given by

Q3ðpÞ ¼ 12 ð2� q�p

t Þð1� p�sqdmax

Þ þ 12q�ptdmax

ðp�sq þ q�s

q Þ,where

the first term is the offline demand and the second

term is online demand.When the retailer operates offline only, the equilib-

rium results are below. When the marginal cost is not

low, that is, c � 116

ffiffiffiffiRt

p , results from our main model

hold qualitatively. When c\ 116

ffiffiffiffiRt

p , the retailer’s par-

ticipation constraint is not binding. As a result, theretailer obtains more than R due to his added abilityto fine-tune the retail price in the linear demandmodel.With continuous consumer heterogeneities both

offline and online, both firms’ profits under offline-exclusive, online-exclusive, and brick-and-click

Table 4 Consumer Types and Utilities when Not All Have OnlineAccessibility

Consumer Type Proportion U1 U2


abc q � p dhq þ s � p


a(1 � b)c q � p dl q þ s � p

Online-inaccessible,offline-accessible

a(1 � c) q � p /


(1 � a)bc / dhq þ s � p

Less-online-skilledoffline-inaccessible

(1 � a)(1 � b)c / dl q þ s � p

Online-inaccessible,offline-inaccessible

(1 � a)(1 � c) / /


options are functions of more than three degrees ofproduct quality. Therefore, we employ a numericalapproach to check if our major qualitative insightshold under this more generalized setting.Specifically, we carry out a series of numerical tests

by taking different combinations of s 2 [0.01, 0.1] anddmax 2 ½0:8; 1�, with t = 0.2, r = 0.01, and c = 0.5. Notethat values of t, r, or c do not affect our qualitativeresults; they only influence the magnitudes of theequilibrium quality and profits. With continuous con-sumer heterogeneities both offline and online, welearn that the retailer’s best-response function is ahigh degree non-polynomial, and the equilibrium canonly be solved in the case of interior solutions. Whenequilibrium results are obtained as interior solutions,we confirm the following results: First, to induce theretailer to carry the new product both offline andonline, the manufacturer may design a low qualityproduct when dmax and/or s is low; and high qualityotherwise. Second, the retailer may gain the mostprofit at the intermediate values of R when the pro-duct is carried both offline and online.We further examine whether we can obtain some

analytical results under a special case where consumerheterogeneity is continuous only in the offline dimen-sion. Specifically, we consider a case where consumersare geographically uniformly distributed on a Hotell-ing line of unit length in the offline market. When pur-chasing the product online, at each location x 2 [0, 1],consumers of type dh (resp., dl) of proportion b (resp.,1 � b) obtain utility dhq þ s � p (resp., dlq þ s � p)by purchasing the product from the online store,where dh and dl are defined the same as in the mainmodel. The total market size is normalized to unity.Under this setup, in the case of online-exclusive,

the equilibrium results remain the same as in themain model. In the case of offline-exclusive, the retai-ler is able to obtain more than R when the offline-par-ticipation constraint, R, is sufficiently low, that is,R\ 1

162c2t. This is due to his added ability to fine-tunethe retail price in the linear demand model. In the caseof brick-and-click, our findings are summarized in thefollowing Lemma 3.

LEMMA 3 (CONTINUOUS OFFLINE HETEROGENEITY). Whenthe offline and/or online heterogeneity is sufficiently large(i.e., t and/or b is sufficiently high) such that the marketis not fully covered, compared with when the retailer onlyoperates offline, the manufacturer may design a productof lower quality when dh and/or s is low (higher qualityotherwise) to induce the retailer to carry the new productboth offline and online.

We discover that, under continuous offline hetero-geneity, whether the market is fully covered when theretailer expands online plays an important role in the

equilibrium outcome. Key insights from the mainmodel remain valid as long as the offline and/oronline heterogeneity is sufficiently large (i.e., t and/orb is sufficiently high). When heterogeneity is consid-erably small, the brick-and-click case may not arisein equilibrium because it will be dominated byeither the online-exclusive or the offline-exclusiveoption.

4.9. Consumers Inspecting the Product Offlinethen Purchasing It OnlineWhen the product is carried both offline andonline, if the retailer charges a lower online price,consumers may first visit the offline store to phys-ically inspect the new product then purchase itonline. We further examine whether our mainresults hold if we take into account such possibili-ties. Consumers are uniformly distributed over aHotelling line from 0 to 1, with the offline storelocated at 0 and t being the unit transportationcost. At each location x, consumers of proportionb are more skillful and obtain utility dhq þ stowards online purchases. And consumers of pro-portion 1 � b are less skillful in this respect, andhence attach dlq þ s (with 0\ dl \ dh \ 1) towardsonline purchases. A representative consumerobtains a utility, q � tx � p2, by first visiting theoffline store and then purchasing the productonline. Hence, the consumer will only engage insuch behavior if (1) she obtains a higher utilitythan directly purchasing the new product online,that is, q � tx � p2 � dq þ s � p2, and (2) sheobtains a higher utility than purchasing it directlyoffline, that is, p2 \ p1. Therefore, consumers whoare located close to the retailer’s offline store,x � 1

t ½ð1 � dÞq � s�, will first inspect the productin-store and then purchase it online.In such cases, the less skillful online shoppers who

locate closer to the retailer’s offline store will firstinspect the product offline then purchase it online.Therefore, the retailer will incur a margin loss, notonly from the switch segment (i.e., more-online-skilled, close to the offline store) as in the main model,but also from some less-skilled online shoppers whoare close to the retailer’s offline store. Hence, the retai-ler incurs a higher margin loss under the brick-and-click strategy in this case than in our main model.Intuitively, the manufacturer will reduce the qualityof the new product to some extent in order to discour-age such behavior, as lower quality implies less offlineinspection benefits. But our overall qualitative resultsfrom the main model still hold. When dh and/or s islow, the equilibrium quality in the case of brick-and-click will be even lower than that in our main model.When dh and/or s is high, as long as not all con-sumers engage in such behavior, the equilibrium


quality in the case of brick-and-click will be reduced,but will still be higher than that in the baseline case.

4.10. Uncertain DemandIn this extension, we examine a scenario where theactual demand may be less or greater than the quan-tity Q ordered by the retailer. Given that the retailerplays a gatekeeper role in our context, we follow thenorm in industry practice by having the manufacturerbear holding and stockout costs. The retailer, on theother hand, incurs a profit reduction when the actualdemand exceeds or is less than the quantity he hasordered. Following a simplified approach to modelsupply shortage in the literature (e.g., Cachon 2003),we assume that the actual demand is a factor, either(1 � k) or (1 + k), of the quantity Q the retailer ordersfrom the manufacturer. Therefore, we have,

~Q ¼ ð1� �ÞQ with probability qð1þ �ÞQ with probability 1� q:

�ð7Þ

In the case of demand overage, the manufacturerincurs a unit holding cost h for unsold quantity kQ.In the case of stockouts, the manufacturer incurs aunit stockout cost l for lost demand kQ. Therefore,the manufacturer’s and retailer’s profit functionsbecome

pmðq;wÞ ¼qð1� �Þ þ 1� qð Þ½ �w�q�hþ 1� qð Þ�l½ � � cq2

( )�Q

prðq;wÞ ¼ qð1� �Þ þ 1� qð Þ½ � � p� wð Þ �Q:

ð8Þ

In regions where the retailer gains a profit of R + r,the manufacturer has to decrease her wholesale pricemore than in the main model to ensure the retailer’swillingness to carry her product. By doing so, themanufacturer absorbs the retailer’s potential profitreduction due to the uncertain demand so that theretailer still gets R + r.When the retailer gains a positive surplus (in an

intermediate region of R ), the manufacturer and theretailer share the profit reduction due to uncertaindemand. The manufacturer offers a lower wholesaleprice in order to partially compensate for the retailer’sprofit decrease. Consequently, the retailer gains alower but still positive surplus. This in turn impliesthat the retailer’s incentive for carrying the productboth offline and online decreases, that is, the size ofthe intermediate region of R where the retailer gains apositive surplus decreases. Moreover, the higheruncertainty measured by k, the smaller the regionwhere the retailer gains a positive surplus.To summarize, with uncertain market demand, the

profits of both firms decrease, with the manufacturerabsorbing more profit loss than the retailer. The

higher uncertainty measured by k, the more profitlosses both firms will face. It is also worth noting that,to keep our analytical model tractable, we use asimplified approach to model demand shortage andoverage. Under this setup, the uncertain demand isnot a function of product quality. Therefore, themanufacturer only adjusts the wholesale price inorder to compensate for the retailer’s profit loss andthe equilibrium quality remains the same as in themain model. If the uncertain demand is a moregeneral function of product quality, we expect thatthe demand uncertainty may also incentivize themanufacturer to increase the product quality (com-pared with the main model) as a second avenue tocompensate for the retailer’s potential profit loss.

5. Managerial Implications andConclusions

With the emerging trend of brick-and-mortar retailersentering the new brick-and-click era, new productmanufacturers face new opportunities as well as newchallenges. When a manufacturer presents a new pro-duct offering to a dual-channel retailer, the ultimatedecision is made by the retailer regarding (1) whetherto stock the new product; and (2) whether to desig-nate the new product to his brick-and-mortar store,online store only, or both. Consequently, the manu-facturer may greatly enhance the success of her newproduct introduction if she takes into account theretailer’s channel outlet designation decisions earlyon. To our knowledge, this study is the first effort inexamining how a manufacturer can strategically useproduct design to influence the retailer’s channel out-let designation decision. Among others, our resultsprovide the following managerial insights:First, we demonstrate that, to induce the retailer to

carry a new product both offline and online, it maynot always be optimal for the manufacturer toenhance product quality (compared with when theretailer only operates offline). Indeed, whenthe online storefront is relatively less appealing to theconsumer (e.g., in product categories such as apparel,furniture, and jewelry), a strategic manufacturer mayintentionally lower the quality of her new product sothat the retailer will opt to carry the product both off-line and online (rather than offline-exclusive). We alsoillustrate that, when targeting the retailer’s brick-and-click option, the manufacturer’s adjusted qualitylevels may reduce market cannibalization.Second, our results also reveal that dual-channel

outlets are one possible effective lever that a retailercould use to influence the manufacturer’s productdesign decisions and hence improve his profit. Whencarefully used, the addition of an online storefrontwill give the retailer additional leverage in accepting


the manufacturer’s new product offering and mayeven bring in an additional profit above and beyondwhat is determined by the sum of his outside optionsfrom the two channel outlets. As a result, the retailermay be incentivized to adjust his participation crite-rion to a level lower than what is determined by hisoutside option.Our study is also subject to limitations that sug-

gest promising avenues for future research. First,although the price setting scheme adopted in ourmain model is applicable to a large number of indus-try practices, our key findings do not hold when theretailer determines both wholesale and retail prices.Future research may further investigate how manu-facturers can incentivize such retailers to accept theirnew product offerings. Second, while we use a sim-plified approach to model demand shortage andoverage in our model extension, future research mayobtain a more refined understanding of impacts fromdemand uncertainty by incorporating a stochasticmarket demand term into a linear demand function.Third, although we emphasize the manufacturer’squality choices around the tipping points where herbest strategy is to switch from offering a single pro-duct (either offline or online) to offering two differentqualities intended for the two different channels,future research may extend our approach to formallyexamine the manufacturer’s product design decisionsin all regions of retailer’s offline participation con-straint. Lastly, we suppress strategic reactions fromincumbent manufacturers as well as retail competi-tion. Future research may build upon our approach tostudy how reactions from competing manufacturersand/or retailers play a role in a focal manufacturer’snew product design decision.

Acknowledgments

The authors thank the department editor, the senior edi-tor, and the review team for their insightful comments onthe manuscript. They are also greatly indebted to feed-back from Anthony Dukes, Sanjay Jain, P.K. Kannan,Matthew Selove, Rajeev Tyagi, Zibin Xu, and JuanjuanZhang on previous drafts of this manuscript. They alsothank seminar participants at Cornell University, PurdueUniversity, Rensselaer Polytechnic Institute, Santa ClaraUniversity, University of Maryland, MSI 50th AnniversarySpecial Session at INFORMS Marketing Science Confer-ence, and the 9th Annual Product and Service InnovationConference for helpful comments. The first authorship isequally shared by the two authors. Author names arelisted alphabetically.

Notes

1Our conversations with industry executives also suggestthat this operationalization is consistent with actual prac-tice in many product categories, such as power tools, toys,

and apparel. Given the large number of new productofferings and the minimal time devoted to any specificproduct (e.g., Wall Street Journal, September 19, 2005, WallStreet Journal, March 21, 2006), a minimum profit thresholdis probably many retailers’ most effective way of contract-ing in attempts to minimize transaction costs (e.g., Luoet al. 2007). As a result, there is ordinarily no negotiationbetween the manufacturer and the retailer on wholesaleprice or product design (e.g., Luo et al. 2007, Wall StreetJournal, September 15, 2005). Due to the large number ofnew product offerings, the retailer also typically avoidsmaking any commitment on product acceptance or chan-nel outlet designation prior to the manufacturers’ newproduct introductions (e.g., Luo et al. 2007).2The physical shelf-space constraint determines that theretailer is often highly selective about any new product heallows in his physical store (Wall Street Journal, September19, 2005). As reported by Hoover’s Company (2011), due toshelf-space limitation, product offerings at Wal-Martstores are only a fraction of those at Wal-Mart.com. Forexample, in contrast to the less than a dozen shoulderbags available at a typical Wal-Mart store, Wal-Mart.comoffers more than 400 different shoulder bags. Similarly, upto 85% of Costco’s online assortment is not found in itsclub locations (Warehouse Club Focus 2011).3For product categories that do not rely much on physicalinspection but enjoy considerable benefits from onlinepurchases (e.g., digital music), we may have d = 1. In suchcases, it is always more profitable to sell the product as anonline-exclusive. As a result, over a period of time, thetraditional store would disappear and only the onlinestore would remain. Thus the dual-channel retailerswould eventually become obsolete in such markets. In thispaper, we focus on the vast majority of markets where thebusiness model of dual-channel retailers is sustainable inthe long run.4Some retailers offer easy or free returns for products soldfrom their online stores. In such cases, some less skilledonline consumers may consider online purchases a viableoption. Nevertheless, with free returns, as long as the con-sumers’ heterogeneity in online shopping skills is suffi-ciently large such that some consumers still prefer makingpurchases offline even with free returns, our qualitativeresults hold.5Because online shelf space is always ample and its oppor-tunity cost r is hence less crucial for the retailer, weemphasize how the equilibrium outcomes change with R.Because the retailer’s offline and online participation crite-ria measure the relative attractiveness of the two channeloutlets, varying the online participation criterion r leads tosimilar results. More details are available from authorsupon request.6Our analytical results suggest that R\ R̂ holds with theonly exception of considerably high online shopping bene-fit s.7We have also considered the possibility that, in the caseof brick-and-click, the retailer’s participation criterionmay be greater or lower than the sum of R and r.Under such scenarios, the brick-and-click option willbecome either less or more attractive relative to the off-line/online-exclusive options (i.e., the region of brick-


and-click in equilibrium will shrink or enlarge), but thequalitative results still hold. To save spaces, the equilib-rium wholesale price is illustrated in Figure B1 inAppendix S2.

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Supporting InformationAdditional Supporting Information may be found in theonline version of this article:

Appendix S1: Empirical Study on Consumers’ Willing-ness-to-Pay for New Product Purchases from Offline Vs.OnlineAppendix S2: Proofs


new product design under channel acceptance: brick-and ... · with traditional brick-and-mortar...

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