Value-Added Retailer in a Mixed Channel: Asymmetric Information and Contract Design

With increasing regularity, manufacturers are opening a direct selling channel using internet, keeping their traditional retail channel in place. This mixed channel is attractive to the manufacturers because they retain the advantage of the retailer’s traditional services while increasing their sales base to customers purchasing online. One disadvantage of this model is the potential for channel conflict because they are in direct competition with their own retailers. In this chapter, we propose an innovative way to mitigate this channel conflict, where the manufacturer allows the retailer to add value to the base product so that it is differentiated from their own offering through the direct channel. We model this supply chain where the retailer is also given the authority to price the value added product. Design of an optimal contract from the manufacturer’s point of view is complicated due to the fact that the manufacturer does not know the retailer’s cost of adding value. This chapter develops the closed form solution of the optimal contracts under this information asymmetry. Comparison with channel coordinating contracts is provided. This chapter develops a number of new managerial guidelines and identifies future research topics.