When manufacturers sell directly to consumers, how do retailers respond?

The phenomenon is called manufacturer encroachment. It is the practice of manufacturers to rely on additional (physical or online) direct channels of their own to reach end-consumers (think the Nike Store, Lego.com or, recently, PepsiCo’s PantryShop). It offers manufacturers visibility and control over the customer experience, yet comes at the cost of upsetting retail-partners. In often mediatized discussions, manufacturers stress direct channels’ benefits as billboards that generate traditional sales as well. Retailers, however, often remain unconvinced and claim that any direct sales could – and should – have been theirs instead. 

Cooperate or compete?

Since few manufacturers can rely only on their own stores, this conflict is troublesome. The dilemma, for manufacturers, is whether, and if so how, retailers will respond. Do retailers embrace the supposed benefit of the direct channel, or do they punish the manufacturer for encroaching on their terrain? Manufacturers need to anticipate this, because these reactions may affect the pricing, presentation, and performance of their brands. 

The natural way for retailers to react to competition is to adjust their marketing mix. Yet when the competition is also a partner that retailers rely on for sales and supply, any price and assortment changes will affect the in-store performance of the very manufacturer they are competing against. Retailers are therefore expected to balance their need to both cooperate and compete with the manufacturer. In new research with co-authors from KU Leuven and Dartmouth College, we show that the power that retailer and manufacturer have vis-à-vis each other co-determines retailer response. For this, we drew on a natural experiment of an online direct channel introduction by a major electronics manufacturer. In a multi-equation panel model, we quantified how power determines retailers’ response to direct channel entry, and in turn influences the brand’s retail performance. 

Who has the power?

We find that two scenarios prevail. Consider, first, retailers that largely depend on the manufacturer for their sales, giving the manufacturer power over them. For these retailers, the direct channel threatens to increase manufacturer power even more. The manufacturer now has a tool to exercise control. For example, it can run promotions that force retailers to run them as well. We theorized and found that these retailers, therefore, are likely to respond to the encroachment by increasing price and decreasing assortment of the manufacturer brand. The result is fewer sales of the brand, yet also a decreased dependence that lowers the manufacturer’s power and makes room to focus on other, more interesting brands. 

For retailers that are powerful vis-à-vis the manufacturer, the situation is different. Their power stems from their capacity to generate a large portion of the manufacturer sales, which makes the manufacturer depend on them. For these retailers, a direct channel threatens to syphon off the sales generated from and for the manufacturer, decreasing their power. We find that these retailers, therefore, respond by decreasing price and expanding assortment of the manufacturer’s product. This blunts the transfer of sales to the manufacturer’s own channel, and thus maintains their source of power vis-à-vis the manufacturer. 

Hence, retail-partners’ reactions to direct channels will vary, guided by whether they preserve or, if possible, enhance retailer power. A powerful manufacturer will compel retailers that depend on it to detach from its power, while a powerful retailer, on whom the manufacturer depends, will seek to preserve its power. How this breaks for the manufacturer in terms of retail performance thus depends on the powers in play. In our empirical setting, the manufacturer lost around 5% retail market share due to retailer response. This demonstrates the risks of manufacturer encroachment, and puts pressure on the direct channel to make up for it. When launching a direct channel, manufacturers therefore should segment retailers according to the power that both parties hold vis-à-vis each other and design appropriate strategies for mitigating reactions that may hurt performance.

Bio: Michiel Van Crombrugge is Assistant Professor at the Erasmus School of Economics’ Business Economics department. His research is focused, among others, on multichannel retailing, retailer-manufacturer relationships and digital transformation.