Who Should Provide the Demand-Enhancing Service? Retailer Strategies on Service Provision in Competitive Channels

As observed in real-world practices, retailers commonly provide the demand-enhancing service to increase product value, but this service can also be outsourced to the upstream manufacturer. The party offering the service faces a tradeoff between the incurred cost of service and the additional revenue generated. Through a service provision strategy matrix based on the question of who is better off by undertaking the service provision, we develop a model of two heterogeneous competitive retailers selling an identical product produced by one manufacturer, and obtain several managerial insights. For instance, we find that the service provision always generates two potential effects: a positive "demand expansion effect" and a negative "service cost effect." The favored retailer always benefits from the demand expansion effect. However, the disfavored retailer does not always benefit from service provision even if the negative service cost effect is transferred through service outsourcing. If the interretailer competition is not very fierce and the two retailers have similar initial market sizes, service outsourcing yields a win–win situation. Interestingly, we identify that two retailers adopting the retailer-provided service is a classic Prisoner's dilemma. Furthermore, we also examine the manufacturer's response and find that the manufacturer obtains a profit when the retailers outsource services. Counter-intuitively, the manufacturer has an incentive to reject service outsourcing since the retailer-provided service can bring more profits. Surprisingly, this initiative rejection strategy always forces the retailers into different Prisoner's dilemmas and decrease the channel efficiency. Furthermore, we discuss some extensions to prove the robustness of our main qualitative insights.