The Strategic Role of Third-Party Marketplaces in Retailing

Abstract

Retailers are increasingly adopting a dual-format model. In addition to acting as traditional merchants (buying and then reselling goods), these retailers also provide a platform for third-party sellers to access and compete for the same customers. In this paper we investigate the strategic rationale for a retailer to introduce a third-party (3P) marketplace, by addressing the following questions: how does the existence of the 3P marketplace alter the outcome of the bargaining game between a manufacturer and the retailer and how does it affect their profits? Our analysis provides insights into the growing prevalence of 3P marketplaces. We show that by committing to having an active 3P marketplace the retailer creates an "outside option" that improves its bargaining position in negotiations with the manufacturer. This can explain the increasing prevalence of such marketplaces. On the other hand, the manufacturer would prefer to eliminate this retailer's outside option and should seek to limit or prevent sales through 3P marketplaces. This is consistent with actions that several manufacturers have taken to limit such sales. Interestingly, if the manufacturer fails to eliminate sales of competing products through the 3P marketplace, then the best strategy for the manufacturer is to allow the retailer to dictate the terms of their contract. This is due to the fact that an all-powerful retailer will rely less on its outside option in generating profit, and therefore it will increase the fees charged to 3P sellers and soften the competition between 3P sellers and the manufacturer. The decrease in competition will lead to an increase in the value of outside option of the manufacturer and improve its profit. Additionally, we find that the presence of a 3P marketplace benefits consumers (due to the introduction of downstream competition), but this benefit diminishes as the retailer is becoming more powerful.