Channel Design and OEM Growth in a Multi-market Setup

Abstract

We study how to design an original equipment manufacturer’s (OEM’s) direct selling channel in a multi-market setup such that the OEM experiences sustained business growth without sacrificing its brand customers’ profits. In this paper, we consider an OEM producing for a brand customer that operates in two markets: the domestic market in which the OEM resides and the international market (i.e., other mature markets). The OEM can offer its brand customers at a discount price in exchange for using the excess capacity to produce products under the OEM’s own brand and then sell these products through its channel. We build a game theoretical model in a Stackelberg setting in which the OEM is the leader and the brand is the follower, and determine their optimal pricing decisions and the associate profits under two different dual channel settings (i.e., one in which the brand cannot flexibly change its retail price and one in which it can). Contrary to the first-order intuition of market cannibalization, we find that the OEM direct selling channel can be a win-win-win strategy for the brand (gaining higher profit margin in the international market), the OEM (gaining a higher market coverage in the domestic market), and consumers in the domestic market (buying the product at a cheaper price). Such insights are generally robust, even when we consider a cost for the OEM’s selling channel, and/or consider a price constraint enforced by the brand, such that the OEM avoids selling the same product at too low a price.