The dark side of bilateral encroachment within a supply chain

Abstract

It is broadly agreed that the opportunity of encroachment is a viable strategy to increase profit. We consider a supply chain in which one manufacturer can encroach by selling national brand products to consumers directly, and one retailer can encroach by developing and selling store brand products. The national brand product is more valued by consumers, whereas the incumbent retailing channel is more cost-efficient. Linear inverse demand functions are derived from consumer utility functions. We assume that two firms move simultaneously and separately to choose their strategies. We then identify the conditions under which each firm should encroach. We find that the strategic channel control role of direct marketing is eliminated by the retailer’s opportunity of encroachment; hence, the manufacturer should not establish the direct channel unless direct sales actually occur. Contrary to conventional wisdom, the analytical results demonstrate that under certain conditions the opportunity of bilateral encroachment can form a prisoner’s dilemma between the manufacturer and the retailer, i.e. the Pareto optimal solution is not to encroach, but encroachment is the optimal strategy for both firms. In addition, we find that the prisoner’s dilemma could be avoided by allowing one firm to move first to choose its strategy.