Product variety, pricing and differentiation in a supply chain

Manufacturers typically sell consumer products through retailers and the presence of intermediaries has interesting ramifications for their product variety and pricing decisions. Retailers may want higher variety to help reduce price competition but the costs of variety are borne by the manufacturer. The increased variety may increase demand and profits for the manufacturer too but this depends on market-specific factors as well as costs. We explore these interactions through a model wherein a manufacturer sells multiple product variants at a wholesale price to two retailers who in turn compete for consumers. Consumers choose between the retailers based on the price and variety offered by each retailer and the search or transportation cost incurred by the consumer, equivalent to the level of retailer differentiation in our model. Several insights emerge from the analysis. The manufacturer offers the same variety to both retailers and this variety increases with market size and consumer sensitivity to variety. We find that some retailer differentiation benefits the retailers (not the manufacturer) but too much differentiation hurts both the retailers and the manufacturer. If the market is fully covered, then the channel is coordinated even with a simple wholesale pricing contract. If the retailers incur costs to sell the product, the manufacturer surprisingly loses out more than the retailers and in fact absorbs some or all of the retailer costs. Finally, asymmetry between retailers has some unexpected consequences. For example, variety is not impacted by asymmetry in consumer preferences for a retailer and the manufacturer offers the same variety to both retailers.