Product diversion by vertically differentiated firms

Abstract

Retail sellers authorized to sell a branded product may divert some units to an unauthorized dealer thus enabling the dealer to become a direct competitor. Because these sellers vary in quality, it is often unclear what type of seller is more motivated to participate in diversion. We develop an analytical model to demonstrate how vertically differentiated sellers make diversion decisions responding to an unauthorized dealer under unique circumstances not considered by previous research. The model demonstrates that when diversion occurs, the low‐quality seller can actually earn a greater profit than the high‐quality seller. Furthermore, a higher quality differential can lead to an overall profit loss for the high‐quality seller when both sellers divert. The sellers will divert products to the competing dealer if and only if they are sufficiently similar to each other. The low‐quality seller has an incentive to divert more units in general, and is motivated to divert alone when the quality differential is not too high. Additionally, changes in vertical differentiation have nonmonotonic effects on the sellers. Overall, the results establish seller vertical differentiation as a new key variable in analyzing product diversion and demonstrate its unique consequences for the authorized sellers and the unauthorized dealer.

Impacts of gray market selling on the supply chain under product upgrade and pricing flexibility decisions

“…Though a few studies have examined the launch of the upgraded version of products in the durable goods industry (e.g., Xiong et al, 2016), the impact of the manufacturer's product upgrade decision on supply chain members in the presence unauthorized gray market selling is completely unexplored. It is observed that such a decision increases the risk of product diversion to the gray market (Smith & Shulman, 2022). This is because the decision of launching an upgraded product pressurizes the retailer to clear the unsold stock of the earlier version of the product to avoid the risk of low salvage value at the end of season.…”

“…However, assumptions of extant supply chain mechanisms deliberated are quite static in terms of their consideration of dynamic aspects, such as short product life cycle, launch of an upgraded version of the existing product, and the retailer's flexibility to adjust the price of the existing product during the selling season. Most importantly, regarding pricing, the extant research has assigned the authorized channel's price as unchanged during the selling season to curtail a realistic view (Smith & Shulman, 2022;Srivastava & Mateen, 2020). Therefore, given this insufficiency in the literature, we examine the viability of capitalizing on empowering the retailer with significant flexibility over pricing decisions to control gray market diversion based on domestic bootlegging.…”

“…Apart from channel incentives, demand uncertainty is another important reason for the emergence of gray markets. Smith and Shulman (2022) reveal that an honest authorized retailer may suffer in terms of shrinking profit margins because of inventory diversion by a dishonest authorized retailer to gray marketers who can in turn compete with these retailers. Given the unstoppable prevalence of domestic bootlegging, scholars have also attempted to evaluate whether gray markets can be utilized to a manufacturer's benefit.…”

“…Gray market-an unauthorized arrangement functioning parallel to the authorized distribution channel-features an unauthorized intermediary (gray marketer) who trades authentic branded products produced by the manufacturer (Li et al, 2022;Smith & Shulman, 2022;Srivastava & Mateen, 2020). A gray market dealer can sell genuine branded products of any focal manufacturer (or brand).…”

When Gray Markets Meet “Made in China”: The Impacts of Global Markets and Value-Added Tax Refund

“…Intuitively, when γ = 0, the MNF’s demand function reduces to the monopoly case. In the Online E-Companion H, we consider the Hotelling model, which is used in some gray market literature (e.g., Smith and Shulman, 2022), and find that main insights are qualitatively robust.…”