Channel selection and pricing in the presence of retail-captive consumers

We analyze channel selection and price setting of a manufacturer who has several distribution options which include selling through (1) a direct channel, (2) a manufacturer-owned retail channel, and/or (3) an independent retail channel. The manufacturer can use any combination of these options. We divide consumers into two segments: (1) a retail-captive segment whose consumers do not use the direct channel and (2) a hybrid segment whose consumers may use either channel. Hybrid segment consumers are heterogeneous in their channel preference. We identify the relative segment sizes and consumers' channel preferences under which different distribution strategies are optimal. Our analysis indicates that the most critical factor in channel selection in a vertically integrated supply chain is the variable cost per unit of product sold using the direct vs. the retail channels. In the presence of independent retailer, the size of the retail-captive consumer segment relative to the size of the hybrid consumer segment becomes a major factor in channel selection.