Pricing policies in dual distribution channels: The reference effect of official prices

Official prices are commonly publicized by firms as reference prices to influence consumers’ valuation of products. By characterizing the reference effect as a general nondecreasing concave function of the official price, we study the timing of pricing decisions in dual distribution channels where a manufacturer distributes the product by a direct channel and an indirect retail channel. We investigate two fundamental pricing policies wherein the manufacturer and the retailer put forward their selling prices simultaneously (ST) or sequentially (SQ). Counter intuitively, our analytical results demonstrate that despite facing a more severe downstream price competition, the manufacturer should charge a higher (rather than a lower) official price in the ST setting than in the SQ setting. In addition, with the reference effect of official price, the ideal case for the manufacturers that operate dual distribution channels is to let the direct channel focus on promoting products and let the retail channel function be the major selling channel, an idea which is supported by the practices of Nike, Apple, and many other leading brands around the world. Furthermore, our numerical examples disclose that the dual-channel efficiency under both decentralized cases (i.e., ST and SQ) increases in the magnitude and variability of the reference effect and the retail channel cost, but decreases in the unit direct channel cost. Finally, we extend our model to incorporate an online direct channel and an offline retailer. We find that, under all of CE, ST and SQ scenarios, the shipping fee charged in the online direct channel will reduce the manufacturer’s total profits by lowering her optimal official prices and direct-sales quantities simultaneously. Managerial implications of this study are discussed.