The Role of Product Quality in Marketplaces

Online retailers who operated as traditional resellers have also started to adopt the marketplace approach, wherein the retailer charges a commission and the supplier determines the retail price. Prior work concluded that marketplace is preferable to wholesale contracting for the retailer if the supplier's quality is known. We study how uncertainty in a supplier's product quality (which may be high or low) affects the retailer's contracting decision; specifically, we identify what contract type – only marketplace, only wholesale, or a combination of marketplace and wholesale (i.e., hybrid) – will prevail. In contrast to marketplace's dominance when quality is known, depending on the heterogeneity in the supplier's product quality, operating only a marketplace may result in either a suboptimal commission rate or the exclusion of the supplier offering high-quality product from the contract. The retailer may then choose a hybrid contract that allows for an equilibrium wherein a low-quality product is sold via marketplace and a high-quality product is sold via wholesale. A key benefit of the hybrid contract is that the retailer can better tailor the contract to each supplier type. Interestingly, under this equilibrium, the supplier is better off than if their quality were certain. Using data from a leading US-based retailer, we empirically verify that products sold via marketplace are associated with lower quality than those sold via wholesale. Our findings provide guidance to retail managers who are transitioning into marketplaces on when the widely used hybrid contract would be advisable to offer. By introducing uncertainty in the supplier's product quality, our work also contributes to the literature by uncovering a new driving force for why the hybrid contract emerges as the retailer's preferred choice.