How Do Retailers Change Their Strategy When Suppliers Like Sony Start Direct Channels of Their Own?

Recently, Sony began selling PlayStation products over its PlayStation Direct online store in the UK, which includes many products available at major retail stores such as Currys and Argos. This is an example of encroachment, when suppliers like Sony, Nike, and Lego establish their own direct channels to reach end-consumers. Such direct channels offer suppliers visibility and control over the customer experience, but they potentially come at the cost of upsetting downstream retail partners who may perceive the direct channel as competition.

This raises an important question for suppliers: Will retailers change their ordering strategies at the encroaching supplier, and if so, how?

Should retailers respond adversely and disengage from the retailer–supplier relationship, typically leading to decreased orders and higher wholesale prices (i.e., an exit response)? Or should they respond cooperatively and engage in constructive discussions with the supplier to seek improved terms of trade, typically leading to lower wholesale prices and increased orders (i.e., a voice response)?

In a new Journal of Marketing study, we analyze the ordering strategy responses of nearly 2,000 retailers that were confronted with a supplier’s launch of their own webshop in the toy industry. Our team found the average retailer chooses an exit response to a supplier direct channel introduction.

Our findings show that, on average, retailers disengage from the retailer–supplier relationship. The average retailer decreases the number of distinct stock keeping units (SKUs) ordered, which is met by the wholesaler increasing prices, possibly reflecting the worsened terms of trade. Specifically, retailers decrease the number of distinct SKUs ordered by 15 (or 18.75%) in the period after the direct channel entry. Possibly due to these fewer orders, they also pay a higher average wholesale price of €.79 (or 20.84%). The increased wholesale price, however, does not compensate for the loss in quantity ordered. The total order value for the average retailer at the supplier decreases by €399.50 (or 11.69%) in the first six months after the direct channel entry.

The Importance of Retailer Power

Such an adverse reaction is troublesome for the encroaching supplier, but not all retailers respond the same way. Our studies provide clear evidence that retailer power is a key driver of ordering strategy responses, such that larger, powerful retailers are much less likely to exit the retailer–supplier relationship than less powerful retailers. In fact, for the largest retailers (75^th percentile), we observe no change in order value.

One mechanism underlying this finding is confidence from powerful retailers that the supplier will continue to support their retail operations despite the introduction of the direct channel. In addition, specialist retailers differ from generalist retailers in their ordering response depending on two countervailing forces.

Specialists experience higher switching costs because these specialized, go-to retailers cannot afford to exclude the brands of important suppliers, which makes it harder to disengage from the relationship.

On the flip side, specialists perceive more channel conflict than generalists because the direct channel threatens their core business, which can evoke stronger emotional inclinations to disengage.

The weights of these two mechanisms determine the specialist retailer’s ultimate decision. Finally, we find the relationship quality between the supplier and retailer to have a substantially lower effect on a retailer’s response than expected. Only when the relationship is particularly strong are we able to find the expected mitigating effect on a retailer’s exit response.

Lessons for Chief Marketing Officers

Our findings offer important insights and caveats to suppliers that consider selling directly to end-consumers.

Introducing direct channels may provide suppliers with opportunities to get closer to their end-customers, but the backlash by retailers makes this step risky because retailers may significantly reduce their orders.

Smaller retailers with less power are more likely to disengage from the relationship after encroachment, driven mainly by their lack of confidence in the supplier.

Suppliers should pay special attention to smaller retailers and design specific incentives and stimuli to increase their confidence and convince them to keep placing orders. This will sacrifice some short-term profits but provides retailers with a credible signal that the supplier wants to minimize the potential harm from the direct channel.

The supplier might reduce the competition created by the direct channel through differentiation. The extent to which channels compete depends on their similarity, in terms of product, price, and/or service. This means the supplier can clearly differentiate what it offers through retailers versus through its direct channel (e.g., channel-specific exclusives, online-only personalization services) to limit competition.