Selling Vertically Differentiated Products under One Roof or Two? A Signaling Model of a Retailer's Roof Policies

• Under one-roof, a retail firm cannot segment consumers and thus offers low services.
• Two roofs enable differential services and capitalization on consumer heterogeneity.
• Two roofs are optimal if benefit from segmentation outweighs additional cost.
• But the result can be incorrect when product quality is not readily observable.

Retail firms commonly offer products of different quality levels to serve different consumer segments. In doing so, some firms adopt a “one-roof policy,” selling all of their products in one store, whereas others adopt a “two-roof policy” to better segment consumers, selling high-quality products in a high-end store and low-quality products in a separate, low-end store. Although roof policies are widely practiced and an important aspect of retail management, they are overlooked in the literature and thus not well understood. In this paper, we look at a multi-product retail firm and explore the implications of roof policy for its quality signaling strategies. In our model, the firm carries two vertically differentiated products to serve two consumer segments. We first demonstrate that when product quality is readily observable to consumers, a two-roof policy yields a greater profit than a one-roof policy if the benefit from segmentation outweighs the cost of an additional roof. Then, we assume that a proportion of consumers are uninformed about quality a priori. We show that under both policies, there exists an equilibrium in which the retailer uses both price and in-store services to signal quality. Surprisingly, now there are conditions under which a two-roof policy is outperformed by a one-roof policy, even if the cost of an additional roof is zero. This result sharply contrasts the conventional wisdom that segmentation is optimal as long as its associated marketing cost is low, and suggests the importance of quality information issues in roof policy decisions.

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