Beyond price mechanisms: How much can service help manage the competition from gray markets?

Companies operating global supply chains in various industries struggle with parallel importers diverting goods from authorized channels to gray markets. While the existing gray market literature mainly focuses on pricing, in this paper we develop a model to examine the role of demand enhancing services as non-price mechanisms for coping with gray markets. We consider a manufacturer that sells a product in two markets and a parallel importer that transfers the product from the low-price market to the high-price market and competes with the manufacturer on price and service. We show that parallel importation forces the manufacturer to provide more service in both markets. We explore the value of service and the effects of competition intensity and market responsiveness to service on the manufacturer's policy. We find that a little service can go a long way in boosting the profit of the manufacturer. Investing in service enables the manufacturer to differentiate herself from the parallel importer and to achieve the ideal price discrimination. In addition, service increases the value of strategic price discrimination when facing parallel importation. We also analyze the case when the manufacturer sells through a retailer in the high price market and can delegate service provision to the retailer or provide service herself. We find that delegating service to the retailer reduces double marginalization and can simultaneously benefit the manufacturer and the retailer, even if the retailer is not as efficient as the manufacturer.