Should traditional retailers function as pre-warehouses of online retailers?

Abstract

We construct a supply chain to investigate the reason why it is uncommon for the traditional retailer to function as the pre-warehouse of the online retailer. The product only offered by the traditional retailer is labelled as the differentiated product, while the product supplied by both the traditional retailer and the third-party suppliers is called the common product. As the online retailer' common product competes directly with the differentiated product, whether the traditional retailer should supply the common product becomes sophisticated. In this paper, we identify an intrinsic rationale for the traditional retailer not to supply the common product, even if he is unambiguously cost advantageous vis-a-vis the third-party suppliers. This is because the online retailer's order serves as a commitment device that puts the traditional retailer at the disadvantageous follower's position in the differentiated and common products competition; moreover, this quantity commitment allows the online retailer to clinch a better bargaining position on the differentiated product. We further show that it never pays the online retailer to split orders between the traditional retailer and the third-party suppliers. Our results are robust against the traditional retailer's capacity constraint, consumers' preference over differentiated and common products, and supply chain contractual form.