Channel differentiation strategy in a dual-channel supply chain considering free riding behavior

Abstract The emergence of e-commerce has compelled original brand manufacturers to adopt cross-channel strategies. This research investigates how a manufacturer facing free riders should decide on channel differentiation strategy, i.e., selling homogeneous or differentiated products through his own online channel and via an independent retailer. We consider horizontal differentiation across channels and identify the optimal strategy. In addition, we develop an agent-based model with vertical and horizontal differentiation to derive managerial insights for more complex situations. We have analytically found: (1) consumers are more likely to engage in free riding when faced with differentiated products than homogeneous products, as the price gap across channels is larger under the former scenario; (2) the manufacturer should offer differentiated products if the free rider's online factor is high. Similarly, if the retailer's service cost is low (high), and online (offline) shopping cost is low, differentiated products should be offered. (3) Under different conditions, offering homogeneous or differentiated products could respectively be a win-win strategy for the manufacturer and the retailer. (4) The proposed channel differentiation strategies remain robust to the horizontal differentiation decision and integration of the retail channel. Through agent-based computational experiments, we derive several insights. Namely, (1) if consumers are highly heterogeneous, the manufacturer should horizontally differentiate products across channels; (2) the manufacturer should narrow the vertical differentiation between the two products in dual channels; and (3) the manufacturer should differentiate products if consumers are familiar with the products.