the internet as a medium for marketing communications: channel
TRANSCRIPT
The Internet as a Medium for Marketing Communications:
Channel Conflict over the Provision of Information∗
Greg Shaffer
University of Rochester
Florian Zettelmeyer
University of California at Berkeley
June 1999
∗We are indebted to Meghan Busse, Carl Shapiro, Miguel Villas-Boas and three anonymous reviewers forcomments and helpful suggestions. We also thank participants of the INFORMS “Marketing Science and theInternet” Conference. Addresses for correspondence: William E. Simon Graduate School of Business, Universityof Rochester, Rochester NY 14627, and Haas School of Business, UC Berkeley, Berkeley CA 94720-1900. E-mail:[email protected], [email protected]
The Internet as a Medium for Marketing Communications:
Channel Conflict over the Provision of Information
Abstract
Traditionally, manufacturers have had to rely on retailers to provide product andcategory related information that is either too technical or too idiosyncratic to beprovided effectively on mass communication channels such as television and printmedia. The emergence of the Internet as a medium for marketing communicationsnow makes it possible for manufacturers (and third parties) also to provide suchinformation. We show that this may lead to channel conflict. In particular, weshow that manufacturers gain and retailers lose from information that makes aretailer’s product offerings less substitutable. We thus conclude that the Internetcan potentially harm retailers even if it is not used as a direct sales channel.
1 Introduction
The Internet is shaking up long established relationships between manufacturers and retailers,
enabling manufacturers to bypass retailers and forge relationships directly with end consumers.
Although most observers see the inherent potential of this for channel conflict, their focus has
been on the use of the Internet as a direct sales channel. In this paper, we argue that the
emergence of the Internet as an interactive medium for marketing communications also poses a
threat to retailers. In particular, we argue that manufacturers will use the Internet to provide
consumers with information about their products that retailers would prefer consumers not
have, and that this can have the effect of altering the balance of channel power.
Traditionally, manufacturers have had to rely on retailers to provide product and category
related information that is either too technical or idiosyncratic to be provided effectively on mass
communication channels such as television and print media. For example, an expert computer
user may want highly detailed, technical information about a computer system in order to assess
its performance, whereas a novice computer user might be interested only in whether his/her
favorite computer game runs on a particular system. Until recently, retailers were uniquely
positioned to provide such information because of their direct access to consumers.
With the emergence of the Internet, it is now possible for manufacturers (and third-parties)
also to provide such information, enabling them to participate in many of the information
provision functions that were once in the exclusive domain of retailers. One consequence of
this is that manufacturers can use the Internet to provide consumers with information that
differentiates their products relative to their rivals’ products, information that retailers selling
both products would not normally provide. We show that manufacturers gain and retailers lose
from information that makes a retailer’s product offerings less substitutable, suggesting that
the Internet can potentially harm retailers even if it is not used as a direct sales channel.
In the interaction between firms and consumers, the Internet can be thought of as affecting
four major areas. First, for many products the Internet lowers the cost to firms of commu-
Consumers
Consumers
FirmsCommunication costs of firms
Communication costs of consumers
Form of communication
Transactional efficiencies
Figure 1: Major areas of change as a result of the Internet
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nicating information to consumers, for example by allowing them to post detailed product
information on a web site or perform post sales support electronically. Second, the Inter-
net lowers the cost to consumers of communicating with firms, for example by reducing their
search costs and providing an outlet for them to express their preferences more easily. Third,
the Internet changes the form of communication; it allows (a) interactivity in the communi-
cation between firms and consumers, (b) consumers’ to interact not just with a firm but also
with other users of the firms’ product and services, and (c) firms to target communications to
individual consumers. Finally, the Internet creates transactional efficiencies, for example by
enabling the integration of firms’ customer interfaces with their back-end operations.1
It is our view that researchers can usefully draw from such paradigms in modelling how the
Internet will affect competition among members of the channel. In this paper we are motivated
by observations in the first three areas of change. First, the lower costs of communication enable
all firms (retailers, manufacturers, and third-parties) to provide virtually unlimited technical
and idiosyncratic information to consumers. Second, consumers’ lower costs of communication
give them easy access to this information. Third, the interactivity in communicating with firms
allows each consumer to look for information that might be relevant only to them without having
to sort through information that is important only to other consumers. In addition, firms can
only communicate with consumers if consumers initiate the contact.
These changes now allow manufacturers and third-parties to perform many of the infor-
mation provision functions that were once performed only by retailers. To model this, we
compare and contrast a stylized “pre-Internet” and “post-Internet” situation using a game-
theoretic structure with bargaining between two manufacturers and a common retailer. In the
pre-Internet scenario, only the retailer can provide idiosyncratic or technical information to
consumers. We assume that the retailer will provide information that increases its profit and
withhold information that decreases its profit. In the post-Internet scenario all firms, including
third-party sources, can provide idiosyncratic or technical information to consumers.
We illustrate the Internet’s potential to cause channel conflict by looking at information
that changes consumers’ perceptions of the degree of differentiation between products. An
example of such information is the display of a comparison-chart that highlights side-by-side
the features of different brands within a product category. Depending on the design of the chart,
such information can emphasize either the similarities or differences between competing product
offerings. One of our main findings is that retailers will prefer to emphasize the similarities
between products, while manufacturers will prefer to emphasize the differences. Casio, for
1Note that the Internet does not lead to these changes for all products. Also, individually some of theseeffects are not unique to the Internet. For example, direct mail also allows firms to target consumers individually;salespeople also engage in interactive communication with customers.
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example, features on its web site a comparison between its Cassiopeia E11 and 3Com’s Palm
III that makes the E11 seem quite different from 3Com’s Palm III. In contrast, retailers such
as netmarket.com or CompUSA either give consumers no basis on which to tell the products
apart or show comparisons that tend to minimize the product differences.
We hypothesize that the Internet’s potential to cause channel conflict varies by product
category. If other communication channels such as television, print, or direct mail already
allow manufacturers to provide differentiating information to consumers, the Internet as a
communications channel is unlikely to have an effect on the perception of consumers and thus
on the allocation of channel profits. For example, mass media are better suited than the Internet
to differentiate products whose perceived differences stem from image advertising. As a result,
we do not expect that the Internet will lead to channel conflict over the provision of information
for categories such as perfume, beer, or softdrinks. In contrast, if perceived differentiation in
a product category is achieved through the provision of detailed or idiosyncratic information
– information for which mass communications channels are ill suited – then manufacturers’
ability to communicate directly with consumers over the Internet will have a larger effect on
the allocation of channel profits. For example, a manufacturer of sofas can use the Internet
to demonstrate to consumers each step of the manufacturing process interactively–thereby
pointing out the quality differences of its product. Similarly, by providing a working software
simulation of the palm pilot, 3Com has made it easier for consumers to experience the ease
of use of their product than the description of their product on the packaging or through an
ad could. Thus, we expect that the Internet will lead to channel conflict over the provision of
information for product categories such as personal digital assistants, furniture and software.
This paper contributes to the marketing literature in three areas. First, it adds to the grow-
ing literature on the marketing aspects and competitive implications of the Internet (Hoffman
and Novak 1996, Alba et al. 1997, Bakos 1997, Bakos and Brynjolfsson 1997, Lal and Sar-
vary 1997, Peterson, Balasubramanian, and Bronnenberg 1997, Zettelmeyer 1997b). Second, it
contributes to the recent literature on the effect of information provision on firms’ competitive
behavior (Zettelmeyer 1997a, Lynch and Ariely 1998). Third, it contributes to the literature
on channel management when competing manufacturers sell through a common retailer (Choi
1991, O’Brien and Shaffer 1997, Shaffer and Zettelmeyer 1999).
Section 2 presents the model. Section 3 shows the presence of channel conflict over the
provision of information on the Internet. Section 4 discusses the results, and section 5 concludes
the paper. The proofs of the propositions are contained in the appendix.
3
2 Model
2.1 Consumers and demand
Consumers are distributed uniformly along the line segment between 0 and 1 and purchase at
most one unit of a product.2 They can choose between two products, one of which is located
at 0 (product X) and the other of which is located at 1 (product Y). All consumers located
at 0 derive a gross utility Vx from consuming product X and Vy − δy from consuming product
Y. All consumers located at 1 derive a gross utility Vx − δx from consuming product X and
Vy from consuming product Y. In general, we assume that all consumers located at z ∈ [0, 1]
derive a gross utility Vx − zδx and Vy − (1− z)δy from the consumption of products X and Y
respectively, where δx > 0 and δy > 0 are the rates at which utility decreases as a consumer’s
ideal point moves away from the locations of products X and Y respectively (see Figure 2).
0 1z
V≈ V¥
V≈-zδ≈ V¥-(1-z)δ¥
Figure 2: Consumers’ valuations for product X and Y
In what follows, we will consider both the case in which channel members would want to
cover the market (serve all consumers) even if they offered only one product to consumers, and
the case in which channel members would not want to cover the market if they offered only
one product. We assume the market is always covered when both products are sold.
2.2 Firms, bargaining and the allocation of channel profits
Suppose firm X produces product X, firm Y produces product Y, and both products are
produced at constant marginal cost which, for convenience, is normalized to zero. These firms,
which we will also refer to as manufacturers, sell their products to a common retailer, who then
distributes the products to consumers. We assume that the retailer is a monopolist.3
2Following in the tradition of the classic spatial model of demand (Hotelling line), the line segment can bethought of as representing a single attribute of differentiation or, alternatively, a ratio of two attributes.
3We do not believe that our results depend on this assumption. See page 18 for a discussion.
4
Our model consists of two stages. In the first stage, the retailer negotiates contract terms
with each manufacturer, bargaining over a per-unit price wi and a way to divide the surplus
which we assume takes the form of a fixed fee Fi, i = x, y.4 In the second-stage, the retailer
chooses how much to buy of products X and Y , and then resells these quantities to consumers.
Let x denote the quantity the retailer buys of product X and let y denote the quantity the
retailer buys of product Y . We assume the firms are profit-maximizers, and that each consumer
maximizes his/her consumer surplus. If the retailer agrees to sell both products, firm X’s
profit is πx = wxx + Fx, firm Y ’s profit is πy = wyy + Fy, and the retailer’s profit is πr =
(px −wx)x+ (py −wy)y − Fx − Fy where px, py, are the retail prices of X and Y respectively.
We solve for each firm’s equilibrium strategy by working backward, taking our assumptions
about the outcome of negotiations as given. Thus, the retailer’s profit-maximizing choices in
the second stage depend on the per-unit prices and fixed fees that were negotiated in the first
stage. If the retailer is indifferent between selling a positive amount of a product and selling
zero, we assume the retailer will choose to sell the positive amount. Given these assumptions,
the retailers’ second stage profit-maximizing choice of x and y is unique in all subgames.
In the first stage, we make minimal assumptions about the bargaining outcomes, assuming
only that bargaining between the retailer and firm i results in maximization of the two players’
joint profit, taking as given the retailer’s contract with firm j, j 6= i, and that each firm earns
its disagreement payoff (what it would earn if negotiations fail) plus a share of the incremental
gains from trade (the joint profit of the retailer and firm i when they trade minus their joint
profit when they do not trade), with proportion λi going to firm i.5 Given these assumptions,
in equilibrium, the negotiated per-unit prices and fixed fees are unique.
In solving, we obtain each firm’s unique equilibrium profit as a function of the bargaining
parameters λx, λy, and the four parameters of demand, Vx, Vy and δx, δy. The complete solution
and proof of Proposition 1 can be found in Shaffer and Zettelmeyer (1999).
4Our restriction to two parameters, wi and Fi, is not necessary for our results. For example, in a previousversion of this paper, we showed that in a game in which two manufacturers make take-it or leave-it offers, Ti,to a common retailer, where Ti : <+ → <+, the unique subgame-perfect equilibrium allocation of channel profitis the same as in Proposition 1, with λi = 1, i = x, y.
5These assumptions are consistent with the commonly used bargaining solutions, (e.g., Nash bargaining,Rubinstein-alternating-offers-bargaining, egalitarian bargaining, and the Kalai-Smorodinsky bargaining), all ofwhich require that players maximize bilateral joint profits and divide the incremental gains from trade.
5
Proposition 1 There exists a unique equilibrium allocation of channel profits to the bargaining
game. If π∗x, π∗y, and π∗r denote firm X, firm Y, and the retailer’s equilibrium profit, then,
π∗x = λx (Πxy −Πy) (1)
π∗y = λy (Πxy −Πx) (2)
π∗r = Πxy − π∗x − π∗y , (3)
where Πxy is the maximized profit that can be earned in the channel if both products are sold
to consumers, and Πx (Πy) is the maximized profit that can be earned in the channel if only
product X (Y) is sold. We refer to the former profit as the total channel profit and to the
latter profit as the monopoly profit of the retailer and firm X (Y). Proposition 1 implies that,
in equilibrium, Πxy is the total profit to be divided among the channel members, and that firm
i earns proportion λi of the difference between the total channel profit and the monopoly profit
of the retailer and its rival, i.e., the incremental profit contributed by its product.6
Note that λi admits several interpretations. For example, if the manufacturers make take-it
or leave-it offers to the retailer, then λi = 1. In this case, each manufacturer earns exactly its
product’s incremental contribution to channel profits. If the retailer makes take-it-or-leave-it
offers to the manufacturers, then λi = 0. In this case, the retailer captures the entire channel
profits and each manufacturer earns zero. Otherwise, the retailer and firm i share in the gains
from trade, e.g., if the retailer and firm i divide the gains from trade equally, then λi = 1/2.
2.3 Deriving maximized channel profits
In our demand framework it is straightforward to derive the maximized channel profits when
a retailer sells product X only (Πx), product Y only (Πy), or both products X and Y (Πxy).
Suppose negotiations with firm Y fail, so that the retailer only offers product X. Then, the
downward sloping line in Figure 2 depicts the fraction of consumers willing to buy product X at
any given price and, hence, represents the inverse demand for product X. Thus, px(x) = Vx−xδx,
x ∈ [0, 1]. It follows that the joint profit of the retailer and firm X is px(x)x (recall that
productions costs are zero), and the joint profit maximizing price and quantity of the retailer
6This raises an interesting question. Suppose the firms do not locate at 0 and 1, but instead locate atc, d ∈ [0, 1]. How are the equilibrium profits affected? To consider this, let Π̃xy(c, d) be the maximized jointprofit of all three firms, Π̃x(c, d) be the maximized joint profit of firm X and the retailer, and Π̃y(c, d) be themaximized joint profit of firm Y and the retailer, when product X is located at c ∈ [0, 1] and product Y is locatedat d ∈ [0, 1]. Then it can be shown that Proposition 1 goes through with firm X earning λx(Π̃xy(c, d)− Π̃y(c, d)),firm Y earning λy(Π̃xy(c, d) − Π̃x(c, d)), and the retailer earning the difference between overall channel profitand the sum of the manufacturer’s profits. We thank an anonymous referee for raising this point.
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and firm X is pmx = Vx/2 and xm = Vx/2δx if the market is not covered (δx > Vx/2) and
pmx = Vx − δx and xm = 1 if the market is covered, yielding profit Πx = pmx xm.
Now suppose instead that negotiations with firm X fail. Then, the upward sloping line
(downward sloping if read from right to left) in Figure 2 depicts the fraction of consumers
willing to buy product Y at any given price and, hence, represents the inverse demand for
product Y. Thus, py(y) = Vy − yδy, y ∈ [0, 1], and the joint profit maximizing price and
quantity of the retailer and firm Y is pmy = Vy/2 and ym = Vy/2δy if the market is not covered
(δy > Vy/2) and pmy = Vy − δy and ym = 1 if the market is covered, yielding profit Πy = pmy ym.
These profits are illustrated in Figure 3 for the case in which the two firms are symmetrically
differentiated, so that pmx = pmy , and in which the market is covered (δ ≤ V/2).
0 1
V≈
0 1
p≈Â
V¥
p¥Â
X Y X Y
Π≈: Monopoly profits of X and the retailer
Π¥: Monopoly profits of Y and the retailer
Figure 3: Monopoly profits
If a retailer sells both products, channel profits are maximized by choosing x and y to solve7
maxx,y
px(x)x+ py(y)y such that x+ y = 1, (4)
where we have assumed that products X and Y are substitutes in demand at the monopoly
prices, i.e., the retailer serves all consumers located in [0, 1]. Solving yields
p∗x = Vx − x∗δx, p∗y = Vy − (1− x∗)δy, and x∗ = (2δy + Vx − Vy)/(2(δx + δy)). (5)
At the optimum, prices are (p∗x, p∗y), consumers located in [0, x∗) purchase product X, con-
sumers located in [x∗, 1] purchase product Y, and total channel profit is Πxy = p∗xx∗+p∗y(1−x∗).
This profit is illustrated in Figure 4 for the symmetric case (p∗x = p∗y).
Since we know from Proposition 1 that each manufacturer captures λi times its product’s
incremental contribution to total channel profit, the symmetric case with full market coverage
7Note that the retailer always chooses x and y in the second stage to maximize its own profit. In equilibrium,it turns out that these quantities also maximize overall channel profit. This implication of games with a commonretailer is discussed in O’Brien and Shaffer (1997) and Shaffer (1998).
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V≈ V¥
0 1
pì ¥ pì ≈
X Y
Π≈¥: Total channel profits
Figure 4: Total channel profits
yields π∗x = λx(p∗ − pmy ), π∗y = λy(p∗ − pmx ), and π∗r = p∗ − π∗x − π∗y , where p∗ = p∗x = p∗y.
2.4 Information and product differentiation
We consider information that may change the degree of differentiation that consumers perceive
between products. An example of such information is the display of a comparison chart that
highlights the features of different brands in a product category. Depending on the design of the
chart, such information can point out the similarities or differences between competing prod-
uct offerings. We say that such information increases (decreases) the differentiation between
products X and Y if the average difference of consumers’ valuations for the products increases
(decreases) after consumers become aware of the information. Formally, let ∆Vx, ∆Vy denote
the change in Vx, Vy, and ∆δx,∆δy denote the change in δx, δy. Then, we say that information
increases the differentiation between products X and Y if and only if
∫ 1
0|(Vx + ∆Vx)− (δx + ∆δx)z − [(Vy + ∆Vy)− (δy + ∆δy)(1− z)]| dz > (6)
∫ 1
0|Vx − δxz − (Vy − δy(1− z))| dz.
For example, consider a symmetric rotation of consumers’ valuations around the location of
the marginal consumer at z=1/2, such that the new curves become Vx + ∆d− z(δx + 2∆d) and
Vy+∆d−(1−z)(δy+2∆d), where the subscript d denotes differentiation. Using (6), we say that
the information increases the differentiation between products X and Y if it leads to ∆d > 0
and decreases the differentiation between products X and Y if it leads to ∆d < 0. We call the
former type of information differentiating, and the latter type of information undifferentiating.
As shown in Figure 5, in the case of differentiating information, the consumer located at 0
prefers product X by a greater margin than he/she did before, while the consumer located at 1
prefers product Y by a greater margin than he/she did before. In the case of undifferentiating
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0 1
Î∂>0 Î∂>0 Î∂<0 Î∂<0
ÎΠ¥<0
X Y0 1X Y
ÎΠ≈<0 ÎΠ¥>0 ÎΠ≈>0
ÎΠ≈¥=0 ÎΠ≈¥=0
Figure 5: Effects of differentiating (left) and undifferentiating (right) information
information, the consumer located at 0 still prefers product X to product Y, but by a lesser
amount than before the information, and analogously for the consumer located at 1.
3 Results
We derive our results by comparing and contrasting a stylized “pre-Internet” and “post-
Internet” scenario. In the pre-Internet scenario, only retailers can provide idiosyncratic or
technical information to consumers. In this benchmark case, we assume retailers will provide
information that increases their profits and withhold information that decreases their profits. In
the post-Internet scenario, retailers, manufacturers, and third-parties can provide information
to consumers. We assume each channel member will use the Internet to provide only infor-
mation that increases its own profit, whereas the information provided by third-party sources
can go either way, sometimes helping and sometimes hurting each channel member. Our pri-
mary focus is on information that increases or decreases consumers’ perceptions of product
differentiation. We also consider information that increases all consumers’ valuations.
To show that retailers can be threatened by the ability of manufacturers and third parties to
communicate directly with consumers, we begin for expositional purposes with the assumption
that all consumers become aware of information that is made available to them. We consider
the implications for channel profit of (a) information that only affects product differentiation
and (b) information that in addition to affecting product differentiation also induces a change
in total channel profit. In section 3.3 we relax the assumption that all consumers become
aware of information that is made available to them. This reflects the fact that in contrast to
traditional communications channels, the interactive nature of the Internet requires consumers
to initiate a dialog that leads to the transmission of information.
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3.1 Information that changes perceived differentiation
Figure 5 provides a good starting point for our analysis, because the rotations isolate the pure
effect of differentiation. Since the valuations of the marginal consumer located at 1/2 do not
change, total channel profit is unaffected. The monopoly profit of the retailer and each firm,
however, is affected, and thus, the information has implications for how total channel profit is
divided. In general, to determine how information affects the profit of each firm we need to
know how it affects total channel profit (∆Πxy) and how it affects the monopoly profit of the
retailer and each firm (∆Πx and ∆Πy). We can then use Proposition 1 to determine which
firms gain and which firms lose from differentiating and undifferentiating information.
Proposition 2 Suppose that in the post-Internet scenario consumers become aware of differ-
entiating (undifferentiating) information. Then, firm X and Y’s profit increases (decreases),
and the retailer’s profit decreases (increases) compared to the pre-Internet scenario.
Proposition 2 implies that both manufacturers gain from information that decreases the
substitutability of their products (left side of Figure 5), and lose from information that increases
the substitutability of their products (right side of Figure 5). By contrast, the retailer loses
from differentiating information and gains from undifferentiating information. This establishes
channel conflict. Intuitively, channel conflict arises because although total channel profit is
unchanged (∆Πxy = 0), the monopoly profit of the retailer with each manufacturer does change.
If the post-Internet scenario is one in which consumers become aware of differentiating
information, the monopoly profit of the retailer with each manufacturer is maximized at a
lower price (since the marginal consumers’ valuation at each endpoint has decreased). This
implies that ∆Πx,∆Πy < 0, and so the incremental contribution of each manufacturer’s product
increases (∆Πxy − ∆Πi > 0). Thus, with differentiating information, the manufacturers can
bargain for better contract terms (higher fixed fees) than in the pre-Internet situation.
If the post-Internet scenario is one in which consumers become aware of undifferentiating
information, the opposite holds. The incremental contribution of each manufacturer’s product
decreases (∆Πxy − ∆Πi < 0), and thus, it is the retailer who is able to bargain for better
contract terms (lower fixed fees) than in the pre-Internet situation.
Which of these post-Internet scenarios is more likely? Clearly, manufacturers are interested
in taking advantage of Internet communications to better their situation and thus we would
expect them to provide only differentiating information. In contrast, we would expect retailers
to provide only undifferentiating information. However, there is an asymmetry in what each
channel member can do post-Internet and what they can do pre-Internet. We would not
expect retailers to gain much from the post-Internet scenario since they already have direct
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access to consumers in the pre-Internet scenario. On the other hand, manufacturers (and third
parties) are gaining much better direct access to consumers in the post-Internet scenario, and
so we would expect that, on balance, Internet consumers will be exposed to relatively more
differentiating information. Channel conflict arises because retailers lose when manufacturers
use the Internet to provide differentiating information that retailers would rather withhold.
3.2 Information that affects total channel profit
We now consider post-Internet situations in which consumers become aware of information that
affects product differentiation and increases total channel profit.8 We model the increase in total
channel profits by adding a vertical shift ∆s > 0 to consumers’ valuations in addition to the
rotation ∆d that captures differentiation. This yields new valuations Vx+∆s+∆d−z(δx+2∆d)
for product X and Vy + ∆s + ∆d − (1− z)(δy + 2∆d) for product Y.
0 1
ÎΠ¥<0
X Y0 1X Y
ÎΠ≈<0ÎΠ¥>0 ÎΠ≈>0
ÎΠ≈¥>0 ÎΠ≈¥>0
Figure 6: Examples of information that increases total channel profits and is differentiating(left) or undifferentiating (right)
The left-side (right-side) diagram in Figure 6 corresponds to the left-side (right-side) dia-
gram in Figure 5, but with a vertical shift upward of both curves by ∆s. This shift increases
maximized channel profits by ∆Πxy = ∆s > 0. If the information is in addition differentiating,
then the monopoly profit of the retailer and each manufacturer changes by ∆Πi = ∆s − ∆d,
which could be positive or negative (recall ∆d > 0 with differentiating information). If the
information is in addition undifferentiating, then the monopoly profit of the retailer and each
manufacturer changes by ∆Πi = ∆s + |∆d| > 0.
If the post-Internet scenario is one in which consumers become aware of information that
increases total channel profit and is differentiating, then ∆Πxy > ∆Πi. Thus, manufacturers
always gain. The retailer’s profit may increase or decrease depending on its bargaining power
and the increase in total channel profit. To illustrate this point we can write the change in the
8The case in which information affects product differentiation and decreases total channel profit can easilybe analyzed using our framework, and is left for the reader.
11
retailer’s profit, using (3), as ∆π∗r = ∆Πxy −∆π∗x −∆π∗y . With the help of (1) and (2) we can
rewrite ∆π∗r as a function of the bargaining parameters λx and λy.
∆π∗r = (1− λx − λy) ∆Πxy + λx∆Πx + λy∆Πy. (7)
Given λx, λy, the retailer gains only if Πxy increases sufficiently. For example, if manufac-
turers have all the bargaining power so that λx = λy = 1, the retailer gains only if the vertical
shift in consumers’ valuations ∆s (and thus the increase in ∆Πxy) exceeds twice the differenti-
ating rotation ∆d (i.e., if ∆s− 2∆d > 0). However, if the retailer has all the bargaining power,
so that λx = λy = 0, then the retailer always gains from information that increases total chan-
nel profit. Intuitively, if the post-Internet scenario is one in which consumers become aware
of information that increases total channel profit by a given amount and is differentiating, the
retailer’s profit is more likely to increase the greater is its bargaining power.
If the post-Internet scenario is one in which consumers become aware of information that
increases total channel profit and is undifferentiating, then ∆Πi > ∆Πxy > 0. In this case, the
effect on firm profits is unambiguous; manufacturers always lose and the retailer always gains.
Proposition 3 Suppose that in the post-Internet scenario consumers become aware of infor-
mation that increases total channel profits. If the information is differentiating, firm X and
Y’s profit increases compared to the pre-Internet scenario, and the retailer’s profit decreases
for ∆s − (λx + λy)∆d < 0 and increases for ∆s − (λx + λy)∆d > 0.9 If the information is
undifferentiating, firm X and Y’s profit decreases, and the retailer’s profit increases.
Which of these post-Internet situations is more likely? We would expect manufacturers to
take advantage of Internet communications to provide information that increases total channel
profit and is differentiating. We would expect retailers to do the same for information that
increases total channel profit and is undifferentiating, and for information that increases total
channel profit and is differentiating, if the latter information increases total channel profits suf-
ficiently. Since retailers can already provide technical information in the absence of the Internet
(because of their direct access to consumers), we reach the same conclusion as before, namely
that as a result of the Internet consumers will become aware of relatively more differentiating
information. Channel conflict arises because retailers lose when manufacturers use the Internet
to provide differentiating information that retailers would rather withhold.
9This assumes δx < Vx/2. See the appendix for the other case.
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3.3 Interactivity and differentiation
We have assumed that all consumers become aware of information that is made available
to them. On the Internet this assumption need not always hold. In contrast to traditional
communications channels, the interactive nature of the Internet requires consumers to initiate
a dialog that leads to the transmission of information. Hence, not all consumers have the
same likelihood of learning the information that manufacturers or third parties provide on
the Internet. We analyze two situations. First, one might think that consumers only initiate
an information exchange from the manufacturers of products that they favor. For example,
users of Windows 98 are more likely to visit Microsoft’s website for information than Apple’s
website and vice versa. Second, one might conjecture that only consumers who expect new
developments to change their preferences are likely to initiate an information exchange with
manufacturers or third parties. For example, a fanatic Macintosh user is more likely to decide
on a purchase without having scouted new developments than a consumer who is close to
indifferent as to which operating system to use and thus expects that new information might
change her mind. Since there is currently not enough evidence about consumers’ use of the
Internet to tell which of these conjectures is more reasonable, we analyze both situations.
Search by consumers at their favored manufacturer
Modelling the effect of interactivity in our framework is conceptually straightforward. We be-
gin by assuming that consumers only initiate an information exchange from the manufacturers
of products that they favor. Thus, if only firm X provides differentiating or undifferentiating
information, only consumers in the interval [0, 1/2) become aware of the information. Con-
sumers’ valuations can be described by Vx + ∆d− z(δx + 2∆d) and Vy + ∆d− (1− z)(δy + 2∆d)
for z ∈ [0, 1/2) and Vx − zδx and Vy − (1 − z)δy for z ∈ [1/2, 1]. Analogously, if only firm Y
provides differentiating or undifferentiating information, only consumers in the interval [1/2, 1]
become aware of the information. Finally, if both firms X and Y provide differentiating or
undifferentiating information all consumers in [0, 1] become informed. Their valuations can be
described by Vx + ∆d − z(δx + 2∆d) and Vy + ∆d − (1 − z)(δy + 2∆d). Figure 7 illustrates
consumers’ valuations for differentiating information in all three cases.
Clearly, if consumers initiate an information exchange only from the manufacturers of prod-
ucts that they favor but both manufacturers make differentiating information available, all con-
sumers’ valuations are updated, yielding the same effect on consumers valuations as described
in section 3.1. However, will firms X and Y unilaterally want to provide consumers with dif-
ferentiating information, i.e., should we expect a post-Internet scenario in which all consumers
become aware of differentiating information, each from the manufacturers of the product that
13
0 1
Î∂>0 Î∂>0
ÎΠ¥<0
X Y0 1X Y
ÎΠ¥>0
0 1
Î∂>0 Î∂>0
ÎΠ¥<0
X Y
ÎΠ≈<0
ÎΠ≈¥=0
ÎΠ≈¥=0ÎΠ≈¥=0
Figure 7: Effects of differentiating information provided by firm X only (top left), firm Y only(top right), and both firm X and firm Y (bottom)
they favor? If firm i provides differentiating information that only changes the valuations
of consumers that favor firm i over firm j, total channel profits remain unchanged but the
monopoly profits of the retailer with firm j, j 6= i decrease. Hence, the incremental contribu-
tion of manufacturer i’s product increases (∆Πxy−∆Πj > 0). Thus, by providing differentiating
information unilaterally, each manufacturer can bargain for better contract terms than in the
pre-Internet situation, even if the rival manufacturer does not provide the information.
Proposition 4 Suppose that in the post-Internet scenario only one manufacturer provides dif-
ferentiating (undifferentiating) information and consumers become aware of information only
from the manufacturer of the product that they favor. Then, the profit of the firm that provides
the information increases (decreases) compared to the pre-Internet scenario.
We conclude that we can expect the same post-Internet scenario, namely one in which all
consumers become aware of differentiating information provided by manufacturers, whether
consumers initiate an information exchange only from the manufacturers of products that they
favor, or whether consumers learn information irrespective of the manufacturer by whom it is
provided (as described in section 3.1). This is captured in the following proposition.
Proposition 5 Suppose that in the post-Internet scenario consumers become aware of differ-
entiating (undifferentiating) information only from the manufacturer of the product that they
favor. Then, firm X and Y’s profit increases (decreases), and the retailer’s profit decreases
(increases) compared to the pre-Internet scenario.
14
Search by consumers who are close to indifferent
We now consider a second situation, which we depict in Figure 8, in which only consumers who
do not have strong preferences for either product (i.e., consumers who are close to indifferent)
are likely to initiate an information exchange with manufacturers or third parties. Intuitively,
these are the consumers who are close to the middle of the line segment, and so we model this
by assuming that only consumers in the interval [l, 1 − l], where 0 < l < 1/2, learn about the
differentiating or undifferentiating information.
0 1
ÎΠ¥=0
X Y0 1X Y
ÎΠ≈=0 ÎΠ¥=0 ÎΠ≈=0
ÎΠ≈¥=0 ÎΠ≈¥=0
Figure 8: Effects of differentiating (left) and undifferentiating (right) information
Since the valuations of the marginal consumer located at 1/2 do not change, total channel
profit is unaffected in both diagrams of Figure 8. For small changes in consumers’ valuations the
monopoly profits of the retailer with each manufacturer are unchanged as well. This is because
the respective marginal consumers located close to or at 0 or 1 do not expect new developments
to change their preferences and are thus unlikely to initiate an information exchange with
manufacturers or third parties. Thus, if only the consumers who are close to the middle of
the line segment look for differentiating or undifferentiating information in the post-Internet
situation, and such information induces only small changes in consumers’ valuations, then there
is no change in channel members’ profits compared to the pre-Internet situation.
In contrast, if the information induces sufficiently large changes in consumers’ valuations,
then we obtain a similar result as when all consumers learn the differentiating or undifferenti-
ating information (section 3.1). Figure 9 illustrates this case.
If the post-Internet scenario is one in which consumers become aware of differentiating
information, the retailer’s monopoly profit with manufacturer X (Y) decreases. This is because
the retailer will either have to lower its price to continue selling to all consumers or because at
the higher price some consumers close to 1− l (l) no longer buy. As a result manufacturers can
bargain for better contract terms than in the pre-Internet situation.
If the post-Internet scenario is one in which consumers become aware of undifferentiating
information, the retailer’s monopoly profit with manufacturer X (Y) increases if the change in
15
0 1
ÎΠ¥<0
X Y0 1X Y
ÎΠ≈<0 ÎΠ¥>0 ÎΠ≈>0
ÎΠ≈¥=0 ÎΠ≈¥=0
Figure 9: Effects of differentiating (left) and undifferentiating (right) information
consumers’ valuations is large relative to l. Then the retailer is better off selling to consumers
located in [0, 1 − l] ([l, 1]) at a higher price than to serve some or all consumers close to the
endpoints of the line at a lower price. As a result it is the retailer who is able to bargain for
better contract terms than in the pre-Internet situation.
Proposition 6 Suppose that in the post-Internet scenario only consumers located in [l, 1− l],where 0 < l < 1/2 become aware of differentiating (undifferentiating) information. Then, forV l−(2−l)δ−1+3l−2l2
≤ ∆d ≤ lδi1−2l , i = x, y, the profits of firms X, Y, and the retailer are unchanged com-
pared to the pre-Internet scenario. For other ∆d, firm X and Y’s profit increases (decreases),
and the retailer’s profit decreases (increases) compared to the pre-Internet scenario.10
If the Internet results in awareness of differentiating (undifferentiating) information only
for consumers who do not have strong preferences for either product, it must have a sufficiently
large effect on consumers’ valuations before manufacturers (retailers) will want to provide it—
assuming that there is a small cost associated with making information available. While third
parties might still want to provide differentiating or undifferentiating information when the
changes in consumer valuations are small, it will not have an effect on the allocation of channel
profit. However, if the changes are large, then channel conflict arises.
In summary, incorporating the effects of interactivity into our model confirms our previous
results. We expect that as a result of the Internet consumers will become aware of relatively
more differentiating information, and that this will lead to channel conflict.
10The condition V l−(2−l)δ−1+3l−2l2
≤ ∆d ≤ lδi1−2l
, i = x, y holds for Vi > 2δi. For 2δi ≥ Vi ≥ (1 − l)2δi the profits of
firms X, Y, and the retailer are unchanged compared to the pre-Internet scenario if and only if (Vi−2δi(1−l))24δi(−1+3l−2l2)
≤∆d <
Vi−(1−l)2δi2−4l
. For (1− l)2δi > Vi, ∆Πi < 0 (∆Πi > 0) for all ∆d > 0 (∆d < 0).
16
4 Discussion
We have shown that retailers can be hurt and manufacturers can gain from information that
decreases the substitutability of a retailer’s product offerings. Manufacturers would like to
provide this kind of information, despite the fact that the retailer can already perform that
role, because they can benefit from providing information that the retailer would like to with-
hold. Until recently, this was not possible when the information was highly idiosyncratic or
technical in nature. The Internet, by reducing the costs of communicating directly with con-
sumers, now makes this information possible. An implicit assumption is that a retailer, through
its interaction with the consumer at the point of purchase, will be biased towards providing
only information that increases the substitution between products.11 This shows that channel
conflict can arise over information that manufacturers want to provide over the Internet.
Thus, the Internet may pose a significant threat to the retailer, even if manufacturers do not
use the Internet as a direct sales channel. By enabling manufacturers to communicate detailed
information at low cost directly to consumers, consumers are more likely to be made aware of
information that is detrimental to the retailer’s profit. Surprisingly, the retailer’s profit can
decrease, even if the information which is provided by manufacturers increases total channel
profit. For a given increase in total channel profit, we have shown that the retailer can gain if
and only if it has sufficient bargaining power to capture a large enough share of the increase.
Thus, we conclude that the Internet will be less of a threat to large retailers, such as Walmart,
and more of a threat to retailers that have limited bargaining power.
In summary, manufacturers will want to use the Internet to decrease the substitutability
of their products relative to their rivals’ products and thus induce a redistribution of chan-
nel profits. If products are more differentiated than consumers believe, we would expect the
manufacturers (and not the retailer) to educate consumers about the products’ differences.
Conversely, if products are less differentiated than consumers believe, we would expect the
retailer (and not the manufacturers) to inform consumers of their similarity.
Testable implications
To the extent that other communication channels such as television, print, or direct mail al-
ready allow manufacturers to provide differentiating information to consumers, the use of the
11We find that retailers in the physical world do just that. For example, Service Merchandise, Staples, CircuitCity, and many other retailers provide consumers with comparison tables for many of their products in productcategories for which manufacturers make comparisons hard. This serves to increase consumers’ perceptions ofthe substitutability between products. Our analysis can also explain the practice of drug-stores (such as CVSPharmacy), which aggressively inform consumers that their generic private label drugs have the same ingredientsas the more familiar branded products; such information is intended to serve not merely to shift market share tothe private label brands, but also to extract more channel profits from the manufacturer of the branded product.
17
Internet for that purpose will differ in consequences. For example, if perceived differentiation
in a product category is achieved primarily through image advertising, the Internet as a com-
munications channel will have little or no effect on the perception of consumers and thus on the
allocation of channel profits. Thus, for example, the Internet is unlikely to allow Phillip Mor-
ris to differentiate Marlboro from Camel to a greater extent than is already possible through
mass media. This is because the differentiation between cigarette brands is not based on the
communication of information for which the Internet is best suited.
In contrast, if perceived differentiation in a product category is achieved primarily through
the provision of detailed or idiosyncratic information – information for which mass commu-
nications channels are ill suited – then manufacturers’ ability to communicate directly with
consumers over the Internet will have a larger effect on the perception of consumers, and thus
on the allocation of channel profits. For example, software falls in this category. The de-
scription of the software on the packaging or through a catalog entry makes it difficult for
consumers to evaluate the look and feel of the product. The Internet, however, by allowing
manufacturers to inform consumers through a downloadable demo version of the software, can
help manufacturers differentiate their products in consumers’ minds.
We thus hypothesize that the Internet’s threat to retailers varies by product category. The
more heterogeneous are consumers’ information needs, or the more information consumers
require to evaluate a product category, and if such information can increase the perceived
differentiation of products, the larger will be the Internet’s effect in reducing retailers’ profits.
Competition among retailers
We have modeled retailers as downstream monopolists primarily for ease of illustration. In
particular, the advantage of this assumption is that it allows us to show diagrammatically the
changes in each firm’s incremental contribution to channel profit as a function of certain types
of information, i.e., differentiating or undifferentiating.
The findings in Gabrielsen and Sorgard (1999) suggest that our results extend to other
market structures as well. In particular they show that the allocation of channel profits, in
which each manufacturer earns its product’s incremental contribution to overall joint profit,
is robust to retailer competition. In their model, two manufacturers simultaneously choose
their retail distribution system. The manufacturers can choose to sell through a common
retailer, as in this paper, or the manufacturers can each choose to sell through an independent
retailer. In the latter case, each retailer can choose from which manufacturer to buy. In each
instance Gabrielsen and Sorgard show that, with take-it or leave-it offers, each manufacturer
earns its product’s incremental contribution to overall joint profit, i.e., the difference between
18
overall joint profit and the monopoly profit of the retailers and one manufacturer if the other
manufacturer’s product is not sold. In our model, overall joint profit is maximized by the
common retailer who internalizes all pricing decisions. In their model, downstream competition
prevents overall joint profit from being maximized. Nonetheless, once this baseline is fixed,
the comparative statics that we do would also hold in their model. In other words, since
our comparative statics rely on changes in each firm’s incremental contribution to channel
profits, and not on the absolute level of channel profits, this difference does not matter for our
qualitative conclusions. Thus, we conclude that our model is robust to downstream competition.
Information asymmetries, veracity, and signaling
We have inferred that firms which benefit from a given type of information are more likely to
provide such information to consumers. This is based on three implicit assumptions. First, we
have implicitly assumed that there is an information asymmetry between consumers and firms
with regard to the information in question. This may be violated in practice since, because
of third-party sources, firms sometimes have no control over whether information becomes
known to consumers or not. In the extreme, if consumers are fully informed of all information
in the pre-Internet scenario, then the emergence of the Internet as a medium for marketing
communications will have no effect on channel profits. More likely, not all consumers will be
fully informed and then there will be a role for the Internet as a communications medium.
We have implicitly assumed, second, that the information provided by firms is verifiable,
so that it is credible to consumers. In reality, however, not all information that is provided
by firms is believed by all consumers. This is more problematic if the information comes
from an interested party, such as a manufacturer or retailer, but less problematic if consumers
receive the information from a credible third-party. To the extent that information provided
to consumers is not credible, this would mitigate the impact of the Internet.
We have implicitly assumed, third, that consumers do not draw conclusions about possi-
ble negative information from the fact that a firm withholds information from them. If this
assumption is relaxed, firms would be pressured to release more information than they would
ideally want to give (to avoid any negative connotations), and this might also mitigate (but not
eliminate) the Internet’s impact. Modeling consumer beliefs is a difficult task, and one that we
leave for future research. Hence, our results should be interpreted with these cautions in mind.
5 Concluding remarks
This paper is driven by the observation that the Internet changes the interaction between
firms and consumers in at least three areas. First, lower costs of communication enable all
19
firms (retailers, manufacturers, and third-parties) to provide virtually unlimited technical and
idiosyncratic information to consumers. Second, the Internet gives consumers easy access
to this information. Third, the interactive nature of the Internet allows each consumer to
look for information that might be relevant only to them. As a result, the Internet enables
manufacturers to perform many of the information provision functions that were traditionally
performed by retailers.
We have shown that the ability of manufacturers to communicate information to consumers
over the Internet can generate channel conflict. This result differs from the conventional view of
channel conflict on the Internet that sees conflict arising because manufacturers are threatening
to use the Internet as a direct sales channel. We have argued that retailers are threatened by
the ability of manufacturers to communicate directly with consumers because manufacturers
are interested in letting consumers know information that retailers would rather withhold from
them. In particular, we have shown that retailers can be hurt and manufacturers can gain from
information that makes the retailer’s product offerings less substitutable. These results take
into account that on the Internet consumers need to initiate the transmission of information
and thus not all consumers have the same likelihood of learning information that manufacturers
or third parties provide. We have also shown that the kinds of information that manufacturers
will provide on the Internet will be less of a threat to retailers such as Walmart (who have
significant bargaining power), and more of a threat to small retailers (whose bargaining power
is limited).
In summary, the Internet can affect distribution channels, even if it is not used as a dis-
tribution channel itself. This is because it allows manufacturers to communicate directly with
consumers at low cost, leading to potential channel conflict over the provision of information.
20
APPENDIX
Proof of Propositions 2 through 6
Recall from equation 5 on page 7 that in equilibrium the retailer prices at p∗x = Vx−z∗δx, p∗y =
Vy− (1− z∗)δy, where z∗ = (2δy +Vx−Vy)/(2(δx+ δy)). The maximum revenue of the retailer
or total channel profit is given by Πxy = p∗xz∗+ p∗y(1− z∗). Substituting equilibrium prices and
market shares and after some simplifications we obtain the following equilibrium total channel
profits and joint profits of the retailer with each manufacturer.
Πxy(Vx, Vy, δx, δy) = (Vx−Vy)2+4Vx δy−4 δx (−Vy+δy)4 (δx+δy)
Πx(Vx, Vy, δx, δy) = V 2x
4δxfor δx > Vx/2
= Vx − δx otherwise
Πy(Vx, Vy, δx, δy) = V 2y
4δyfor δy > Vy/2
= Vy − δy otherwise
(A-1)
Let ∆Πxy = Πxy(Vx + ∆Vx, Vy + ∆Vy, δx + ∆δx, δy + ∆δy)−Πxy(Vx, Vy, δx, δy) and define ∆Πx
and ∆Πy analogously. Using proposition 1 we can then write the profit changes of each firm
as a function of information induced changes in Vx, Vy and δx, δy.
∆πx(∆Vx,∆Vy,∆δx,∆δy) = λx(∆Πxy −∆Πy)
∆πy(∆Vx,∆Vy,∆δx,∆δy) = λx(∆Πxy −∆Πx)
∆πr(∆Vx,∆Vy,∆δx,∆δy) = λx∆Πx + λy∆Πy + (1− λx − λy)∆Πxy
(A-2)
By the assumption that a multiproduct monopolist serves all consumers located in [0,1],Vx2δx
> 1− Vy2δy
, which is equivalent to V > δ in the pre-Internet scenario.
Propositions 2 and 3 Let ∆Vx = ∆d + ∆s,∆Vy = ∆d + ∆s,∆δx = 2∆d,∆δy = 2∆d.
By the assumption that a multiproduct monopolist serves all consumers located in [0,1] after
the consumers learn the information, ∆d − ∆s < V + δ. In the following we present several
cases that distinguish between full and partial market coverage when the retailer sells only the
product of one of the manufacturers. Proposition 2 follows as a special case with ∆s = 0 from
this proof of proposition 3.
Assume V > 2δ,∆d ≤ (V − 2δ + ∆s)/3 (full monopoly market coverage in the pre and
post-Internet scenario when only one product is sold). Evaluating (A-2) yields after some sim-
plifications {∆πx,∆πy,∆πr} = {λx∆d, λy∆d,∆s− (λx + λy)∆d}. Assume ∆s = 0 (proposition
21
2); by inspection ∆πi > 0, i = x, y and ∆πr < 0 for ∆d > 0, ∆πi < 0, i = x, y and ∆πr > 0
for ∆d < 0. Assume ∆s > 0 (proposition 3); by inspection ∆πi > 0, i = x, y for ∆d > 0 and
∆πi < 0, i = x, y for ∆d < 0. Also, ∆πr > 0 for ∆s − (λx + λy)∆d > 0 and ∆πr < 0 for
∆s − (λx + λy)∆d < 0.
Assume V > 2δ,∆d > (V − 2δ + ∆s)/3 (full monopoly market coverage in the pre-
Internet scenario and partial monopoly market coverage in the post-Internet scenario when
only one product is sold). Notice that this implies ∆d ≥ 0. Then {∆πx,∆πy,∆πr} =
{λx(V − δ + ∆s − (V+∆d+∆s)
2
4 (δ+2 ∆d)
),
λy(V − δ + ∆s − (V+∆d+∆s)
2
4 (δ+2 ∆d)
),∆s − (λx + λy)
(∆s + V − δ − (V+∆d+∆s)
2
4 (δ+2 ∆d)
)}. By ∆d −∆s <
V + δ one can easily see that ∂∆πi∂∆d
= −λi (δ+∆d−∆s−V )(∆d+∆s+V )2(δ+2∆d)2 > 0. Evaluate ∆πi at the
smallest admissible ∆d = (V − 2δ + ∆s)/3. This yields ∆πi = (V − 2δ + ∆s)/3 > 0, i = x, y
since V > 2δ and ∆s ≥ 0 by assumption. See below for the profits of the retailer.
Assume V ≤ 2δ,∆d > (V − 2δ + ∆s)/3 (partial monopoly market coverage in the pre and
post-Internet scenario when only one product is sold). Then {∆πx,∆πy,∆πr} =
{λx(∆s + V 2
4δ −(V+∆d+∆s)
2
4 (δ+2 ∆d)
), λy
(∆s + V 2
4δ −(V+∆d+∆s)
2
4 (δ+2 ∆d)
),
∆s − (λx + λy)(∆s + V 2
4δ −(V+∆d+∆s)
2
4 (δ+2 ∆d)
)}. By ∆d − ∆s < V + δ one can easily see that
∂∆πi∂∆d
= −λi (δ+∆d−∆s−V )(∆d+∆s+V )2(δ+2∆d)2 > 0. Evaluate ∆πi at the smallest (largest) admissible
∆d = 0 under the assumption that ∆d ≥ 0 (∆d ≤ 0). This yields ∆πi = 0, i = x, y. Since∂∆πi∂∆d
> 0, ∆πi > 0 (∆πi < 0) for ∆d > 0 (∆d < 0). See below for the profits of the retailer.
Assume V ≤ 2δ,∆d ≤ (V −2δ+∆s)/3 (partial monopoly market coverage in the pre-Internet
scenario and full monopoly coverage in the post-Internet scenario when only one product is
sold). Notice that this implies ∆d ≤ 0. Then {∆πx,∆πy,∆πr} = {λx(−V + V 2
4 δ + δ + ∆d
),
λy(−V + V 2
4 δ + δ + ∆d
),∆s− (λx + λy)
(−V + V 2
4 δ + δ + ∆d
)}. Since ∂∆πi
∂∆d= λi > 0 we eval-
uate ∆πi at the largest admissible ∆d = (V −2δ+∆s)/3. This yields ∆πi = λi(V2
4δ −(2V−δ)
3 ), i =
x, y. It can be easily seen that ∆πi < 0 for V/2 < δ < 3V/2. Since by assumption V/2 < δ < V ,
∆πi < 0, i = x, y for all admissible δ.
In each of the three last cases we can rewrite the retailer’s profits as ∆πr = ∆s − (λx +
λy)(∆s − ∆Πi). For V > 2δ and ∆d > (V − 2δ + ∆s)/3, ∆Πi =(−V + δ − (V+∆d+∆s)
2
4 (δ+2 ∆d)
).
For V ≤ 2δ and ∆d > (V − 2δ + ∆s)/3, ∆Πi =(−V 2
4δ + (V+∆d+∆s)2
4 (δ+2 ∆d)
). Finally, for V 2δ and
∆d ≤ (V − 2δ + ∆s)/3, ∆Πi =(V − V 2
4 δ − δ −∆d + ∆s
). Note that for each of these cases
∂∆Πi∂∆d
< 0. Assume ∆d > 0. Then, ∆πr > 0 for ∆s − (λx + λy)(∆s − Πi) > 0 and ∆πr < 0 for
∆s − (λx + λy)(∆s − Πi) < 0. Assume ∆d < 0. It can then be easily shown for ∆s ≥ 0 that
∆πr > 0 in each of the three cases.
Q.E.D.
22
Proposition 4 We show first that the retailer’s profit maximizing prices p∗x, p∗y do not change
when manufacturer i unilaterally provides information that is only learned by consumers located
in [0, 1/2) (firm X) or in [1/2, 1] (firm Y). Second, we show that ∆πi > 0 (∆πi < 0) if
manufacturer i unilaterally provides differentiating (undifferentiating information).
Assume that only firm X provides differentiating or undifferentiating information. Let the
marginal consumer be located at z′. By the assumption that a multiproduct monopolist serves
all consumers located in [0,1], the monopolist’s maximization problem can be written as
maxz′,px,py
pxz′ + py(1− z′) (A-3)
such that Vx+∆d−z′(δx+2∆d)−px = 0, Vy +∆d− (1−z′)(δy +2∆d)−py = 0 for z′ ∈ [0, 1/2)
and Vx − z′δx − px = 0, Vy − (1 − z′)δy − py = 0 for z′ ∈ [1/2, 1]. Substituting for px, py in
pxz′ + py(1 − z′) and taking the derivative w.r.t. z′ we obtain 2(δ + 2∆d)(1 − 2z′) > 0 for
z′ ∈ [0, 1/2) and 2δ(1− 2z′) < 0 for z′ ∈ [1/2, 1]. Since consumers’ valuations are continuous in
z, the multiproduct monopolist maximizes profits with z∗ = 1/2 and prices that are unchanged
from the benchmark case. This shows that ∆Πxy = 0.
Since consumer valuations in the post-Internet scenario for z′ ∈ [0, 1/2) correspond to those
in proposition 2, ∆πx = ∆Πxy − ∆Πy = −∆Πy is derived in the proof of propositions 2 and
3. This shows that ∆πx > 0 for ∆d > 0 and ∆πx < 0 for ∆d < 0. Hence, firm X has
incentives to provide differentiating information, even if only consumer located in [0, 1/2) learn
the information. By symmetry, the same argument holds for firm Y.
Q.E.D.
Proposition 5 In the post-Internet scenario the valuation of a consumer located at z ∈[0, 1/2) is Vx + ∆d − z(δx + 2∆d) for product X and Vy + ∆d − (1− z)(δy + 2∆d) for product
Y. The valuation of a consumer located at z ∈ [1/2, 1] is Vx + ∆d − z(δx + 2∆d) for product X
and Vy + ∆d− (1− z)(δy + 2∆d) for z ∈ [1/2, 1]. Thus, the post-Internet situation corresponds
to the one described in Proposition 2. The claims hold by Proposition 2.
Q.E.D.
Proposition 6 In the post-Internet scenario the valuation of a consumer located at z ∈ [0, l)
or z ∈ [l, 1], , l < 1/2 is Vx − zδx for product X and Vy − (1 − z)δy for product Y. The
valuation of a consumer located at z ∈ [l, 1 − l) is Vx + ∆d − z(δx + 2∆d) for product X and
Vy + ∆d − (1 − z)(δy + 2∆d) for product Y. Consider a monopolist who sells product X only.
Let pm1x be the profit maximizing price for ∆d = 0, i.e. in the pre-Internet scenario. Let zm1
x
23
be the location of the marginal consumer when the monopolist charges pm1x .12 Let pm2
x be the
profit maximizing price for ∆d 6= 0, i.e. in the post-Internet scenario. Let zm2x be the location
of the marginal consumer when the monopolist charges pm2x .
Assume ∆d < 0.
Suppose Vx ≤ (1 − l)2δx. Then at pm1x , zm1
x ∈ [1/2, 1 − l]. Then at pm2x , zm2
x ∈ [1/2, 1 − l]since consumer valuations in (1 − l, 1] are unchanged and pm1
x , zm1x ∈ [1/2, 1 − l] maximizes
profits for ∆d = 0. Suppose Πm2x ≤ Πm1
x . Let prx be the reservation price of the consumer at
zm1x . prx > pm1
x for ∆d < 0. Suppose prx = pm2x . This implies Πm2
x = prxzm1x > pm1
x zm1x = Πm1
x
which contradicts Πm2x ≤ Πm1
x . Suppose prx 6= pm2x . Since pm2
x maximizes profits for ∆d < 0,
Πm2x = pm2
x zm2x > prxz
m1x > pm1
x zm1x = Πm1
x which contradicts Πm2x ≤ Πm1
x . Hence, ∆Πx > 0 for
∆d < 0 and by symmetry ∆Πy > 0 for ∆d < 0.
Suppose Vx > (1 − l)2δx. Then at pm1x , zm1
x ∈ (1 − l, 1]. Notice first that there cannot
exist a profit maximizing price pm2x for which zm2
x ∈ [1/2, 1− l) because Vx > (1− l)2δx implies
zm2x = ∆+V
2δx+4∆ > 1− l. This leaves the following candidates for the profit maximizing price pm2x .
If at pm2x , zm2
x ∈ (1− l, 1] then pm2x = pm1
x since consumer valuations in (1− l, 1] are unchanged.
If at pm2x , zm2
x = 1− l, pm2x = p+
x ≡ Vx + ∆d− (1− l)(δx + 2δx) with the corresponding location
of the marginal consumer z+x = 1− l.
Suppose Vx > 2δx. This implies zm1x = 1 and thus Πm1
x = Vx − δx. Then Πm1x < p+
x z+x iff
∆d <lV+δx(l−2)−1+3l−2l2
where lV+δx(l−2)−1+3l−2l2
< 0 (by Vx > 2δx). Thus, Πm2x = p+
x z+x for ∆d <
lV+δx(l−2)−1+3l−2l2
and Πm2x = Πm1
x for ∆d ≥ lV+δx(l−2)−1+3l−2l2
.
Suppose (1 − l)2δx < Vx ≤ 2δx. This implies zm1x ∈ (1 − l, 1) and thus Πm1
x = V 2x
4δx. Then
Πm1x < p+
x z+x iff ∆d <
(V−2δx(1−l))2
4δx(−1+3l−2l2)where (V−2δx(1−l))2
4δx(−1+3l−2l2)< 0 (by Vx > (1 − l)2δx). Thus,
Πm2x = p+
x z+x for ∆d <
(V−2δx(1−l))2
4δx(−1+3l−2l2)and Πm2
x = Πm1x for ∆d ≥ (V−2δx(1−l))2
4δx(−1+3l−2l2).
By the assumption that a multiproduct monopolist serves all consumers located in [0,1],
∆Πxy = 0 for any ∆d. For ∆d < 0 we thus conclude ∆πi = −∆Πi = 0, i = x, y and ∆πr =
∆Πi = 0 if and only if Vi ≥ (1− l)2δi and ∆d is sufficiently small (∆d ≥ lVi+δi(l−2)−1+3l−2l2
for Vi > 2δiand ∆d ≥ (Vi−2δi(1−l))2
4δi(−1+3l−2l2)for Vi ≤ 2δi). Otherwise, ∆πi = −∆Πi < 0 and ∆πr = ∆Πi > 0.
Assume ∆d > 0.
Assume that no consumers in [zm2x , 1] purchase product X. Suppose Πm2
x ≥ Πm1x . The
reservation price prx of the marginal consumer at zm2x increases as ∆d decreases. Suppose
prx = pm1x . This implies Πm2
x < Πm1x which contradicts Πm2
x ≥ Πm1x . Suppose prx 6= pm1
x . Since
pm1x maximizes profits for ∆d = 0, Πm1
x = pm1x zm1
x > prxzm2x > pm2
x zm2x = Πm2
x which contradicts
Πm2x ≥ Πm1
x . Hence, ∆Πx < 0 for ∆d > 0 and by symmetry ∆Πy < 0 for ∆d > 0.
12Notice that zm1x ∈ [1/2, 1] by the assumption that a multiproduct monopolist serves all consumers located
in [0,1].
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Assume that some consumers in [zm2x , 1] purchase product X. Let z++
x be the location of the
marginal consumer in [zm2x , 1]. It follows that consumers in [1− l, z++
x ] (and [0, zm2x ]) purchase
the product. Let Πm2x be the maximized monopoly profits and suppose that Πm2
x ≥ Πm1x .
Suppose pm2x = pm1
x . It follows that zm1x = z++
x ≥ 1 − l > zm2x . Thus, Πm1
x = pm1x zm1
x >
pm1x (zm1
x − (1 − l) + zm2x ) = pm2
x (z++x − (1 − l) + zm2
x ) = Πm2x which contradicts Πm2
x ≥ Πm1x .
Suppose pm2x 6= pm1
x . Since pm1x is the profit maximizing price for ∆d = 0 it follows that
Πm1x = pm1
x zm1x > pm2
x z++x ≥ pm2
x (z++x − (1 − l) + zm2
x ) = Πm2x , which contradicts Πm2
x ≥ Πm1x .
Hence, ∆Πx < 0 for ∆d > 0 and by symmetry ∆Πy < 0 for ∆d > 0.
Assume that at pm2x all consumers buy in [0, z++
x ] purchase product X. Let z++x be the
location of the marginal consumer in [zm2x , 1]. Let Πm2
x be the maximized monopoly profits
and suppose that Πm2x ≥ Πm1
x . Suppose pm2x = pm1
x . It follows that zm1x = z++
x and thus
Πm2x = Πm1
x . Suppose pm2x 6= pm1
x . Since pm1x is the profit maximizing price for ∆d = 0 it follows
that Πm1x = pm1
x zm1x > pm2
x z++x = Πm2
x , which contradicts Πm2x ≥ Πm1
x .
Thus, Πm2x = Πm1
x if and only if pm2x = pm1
x where all consumers buy in [0, z++x ]. For
Vx > 2δx, pm1x = Vx − δx which implies ∆Πx = 0 iff ∆d <
lδx1−2l . For 2δx ≥ Vx > (1 − l)2δx,
pm1x = Vx/2 which implies ∆Πx = 0 iff ∆d <
Vx−(1−l)2δx2−4l . For (1 − l)2δxx, ∆Πx < 0 for all
∆d > 0 since Vx−(1−l)2δx2−4l < 0 contradicts ∆d <
Vx−(1−l)2δx2−4l .
By the assumption that a multiproduct monopolist serves all consumers located in [0,1],
∆Πxy = 0 for any ∆d. For ∆d > 0 we thus conclude ∆πi = −∆Πi = 0, i = x, y and ∆πr =
∆Πi = 0 if and only if Vx > (1− l)2δx and ∆d is sufficiently small (∆d <lδi
1−2l for Vi > 2δi and
∆d <Vi/2−(1−l)δi
1−2l for Vi ≤ 2δi). Otherwise, ∆πi = −∆Πi > 0 and ∆πr = ∆Πi < 0.
Q.E.D.
25
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