Selling vertically differentiated products under one channel or two? A quality segmentation model for differentiated distribution channels

Many manufacturers, including Lenovo, Sony, Procter & Gamble, and Buckle, have adopted differentiated distribution channels to market vertically differentiated products. However, there is scant literature addressing the issue of quality differentiation in the presence of differentiated distribution channel policies. To fill this void, we examine whether (how) differentiated channel policies affect manufacturers’ quality differentiation and all parties’ performance. Specifically, we consider a manufacturer who produces two vertically differentiated products (high- and low-tier) together, but with two marketing options: (1) distributing both products through one retailer (Model O, the one-channel policy), or (2) providing high-quality products through one retailer but low-tier products through another (Model T, the two-channel policy). Our results show that the manufacturer is more likely to decrease the level of quality differentiation in Model T than in Model O. Moreover, contrary to popular belief, we show that “quality distortion” is not limited to low-tier products but can occur with high-tier products. Among other results, we find that the one-channel policy benefits the retailer but hurts both the manufacturer and the total supply chain. To test the robustness of the results, we extend both models to the case in which consumers are not only vertically heterogeneous with quality attributes, but are also horizontally heterogeneous for search costs. Numerical studies further validate our conclusions. Key words: OR in marketing; Quality segmentation; Channel policy; Manufacturing/Marketing interface