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Supplier Encroachment as an Enhancement or a Hindrance to Nonlinear Pricing

The objective of this study was to extend existing understanding of supplier encroachment to contexts in which there is information asymmetry and the supplier can use nonlinear pricing. Prior research has shown that supplier encroachment can mitigate double marginalization and thus benefit both the supplier and the reseller. However, under symmetric information, this benefit disappears if the supplier can use nonlinear pricing. In our model, the reseller observes the true market size while the supplier knows only the prior distribution, that is, a seemingly ideal setting for implementing mechanism design through nonlinear pricing. We first show that, because encroachment capability enables the supplier to make an ex post output decision, it fundamentally alters the structure of the optimal nonlinear pricing policy. In addition to the usual downward distortion effect, where the reseller may purchase less than the efficient quantity, we also have the possibility for upward distortion. Thus, under asymmetric information and nonlinear pricing, supplier encroachment has two opposing effects. On one hand, the ability to shift sales to the direct channel allows the supplier to reduce information rents with less sacrifice of efficiency; but on the other hand, by introducing the possibility of her own opportunistic behavior, it can result in upward distortion of the quantities sold through the reselling channel, which is a new source of inefficiency. Depending upon the relative efficiency of the reselling channel and the demand distribution, either of these two effects may dominate and the supplier's ability to encroach may either benefit or hurt both the supplier and the reseller.