Channel Structure, Cross Sales, and Vertical Integration in a Multi-channel Distribution System

Consider two manufacturers, each producing a single substitutable product. In any geographical area, there are two retail outlets through which the products are sold to the end consumers. Each of the two retail outlets could be privately owned (i.e. a franchised outlet) or owned by the manufacturer (i.e. a vertically integrated company store). Each manufacturer makes vertical integration decision in its best interest. However, a manufacturer incurs a fixed cost to establish an integrated channel. A manufacturer is not restricted to using only one retail outlet. We define cross sales to be the situation where at least one retail outlet sells both products. The objective of our paper is to analyze the cross sales phenomenon. We propose a game theoretic model to accomplish this objective. Our model provides answers to the following questions. When will cross sales occur in the multi-channel distribution system described above? How does the nature of competition influence cross sales? What are the equilibrium channel configurations under the scenario described above? We show that cross sale will happen in quantity competition or in a capacity constrained price competition. However, cross sales may never happen in a pure Bertrand price competition. We provide interesting and intuitive explanation for the cross sales phenomena, which to the best of our knowledge, have not been studied in the context of channel design before. We also identify various interesting economics of cross sales.