Company Stores vs. Independent Retailers: Clash or Peaceful Coexistence?

Microsoft dipped its toe into retail waters this month by opening its first company store — a shop situated in an Arizona mall that’s meant to showcase the latest and greatest in PCs, Zunes and Xbox consoles. The Microsoft move was widely seen as a bit of catch-up with rival Apple, which at the end of 2008 operated some 247 retail stores around the world. But computer companies aren’t the only manufacturers moving into the retail space, says David Bell, a professor of marketing at the Wharton School.

Whether it’s handbags from Coach, shoes from Nike or suits from Ralph Lauren, consumers increasingly have the choice to buy products either at stores operated by manufacturers or from independent retailers. The motivation for these manufacturers might be more obvious if they set up shop in markets where their products otherwise lacked any sort of retail presence. But most company stores, Bell says, are landing in close proximity to independent retailers who already offer many of the manufacturer’s products.

As such, the phenomenon of the company store next door raises a number of intriguing questions. Isn’t it inefficient for Nike to operate a shop when a nearby Foot Locker is ready and willing to handle demand? Doesn’t Ralph Lauren run the risk of antagonizing other retailers that sell his suits by opening a shop in the same mall? Might computer manufacturers remove incentives for independents to properly promote Microsoft and Apple products if their retail stores do the heavy lifting of educating the market?

Bell and two colleagues — Yusong Wang from Fudan University and Paddy Padmanabhan from INSEAD — set out to address these questions in a paper titled, “Manufacturer-owned Retail Stores” (PDF), recently published in the journal Marketing Letters. They conclude that when company stores and independent retailers compete in the same market, manufacturers set relatively high prices for goods in their own stores. That creates room for independents to set discounts that don’t go as deep as when company stores aren’t there. In addition, the presence of company stores can induce independent retailers to provide more retail marketing efforts that enhance the manufacturer’s brand. “The presence of a company store provides an incentive for independent retailers to charge more and to invest more in non-price marketing activity,” Bell and his colleagues write in the paper.

The researchers used a series of mathematical models to simulate and analyze the marketing and price-setting behaviors of independent and manufacturer-owned retailers. The models showed that company stores charge more for the same product than independents when they compete in close proximity to one another. The models also showed that company stores spend more on marketing efforts.

On the surface, the results don’t look very good for manufacturers since, by opening company stores, they seem to be investing heavily in shops that just aren’t price competitive. But the models pointed to an important silver lining. Independent retailers wind up charging more for a given product when competing against a company store than they would if competition existed solely among the independents. What’s more, the models show that independent retailers exert more marketing effort when competing against a company store, so long as the “effort spillover” from the manufacturer’s store — the phenomenon of one retailer’s marketing and product education efforts helping to create a sale for another — is sufficiently large. A rising marketing tide, in other words, can raise all boats, and the presence of the company store helps establish this dynamic where collective marketing efforts drive sales at many shops.

Checking Out the Malls

Bell and his colleagues took the findings and put them to the test both on the Internet and at the shopping mall. In one study, Bell and a team of researchers walked the halls of two malls and examined prices for 47 apparel and shoe items being sold by company stores and/or independents. They found that independent retailers were less likely to discount a brand item when the product’s manufacturer also operated a store in the mall. The anecdotal evidence, in other words, confirmed one of the conclusions from the mathematical models.

In another study, Bell and some colleagues visited seven California malls populated by both company stores and independent retailers, and looked at prices for a sample of 23 products carried in both shop types. Chance alone would dictate that the company stores would charge a higher price half the time, the researchers say. But manufacturer-owned stores actually charged higher prices at a disproportionate rate — 74% of cases. So, again, the ground-level conclusion matched that from the models: Company stores don’t undercut independents on price.

Doing research about retail marketing on the Internet requires less shoe leather, Bell points out, since price and non-price information from a number of competitors is conveniently located on the web. It meant he could enlist students to help him gather information from 332 different web sites about the prices being charged for 161 products ranging from personal computers and digital cameras to household appliances and fashion apparel. Students also helped grade the quality of the marketing materials on the web sites. The results: The mean price for the products was $574.12 at manufacturer web sites, which was significantly higher than the mean price of $543.79 at independent web sites. In addition, manufacturer web sites provided more quality information about the products. Again, the real world anecdote supported the mathematical model.

“We have obtained new findings that help explain why manufacturer-owned stores might be present in the retail market and implicitly why independent retailers might tolerate them,” the researchers write.

A Ceiling on Prices

The finding that company stores set higher prices than independents do, Bell points out, is contrary to the traditional concern that manufacturers might use retail stores to engage in “price squeezing.” For years, legal battles have been fought over whether manufacturers with company stores have charged higher wholesale prices to independent retailers, and then unfairly plowed that margin back into their own operations. The research shows that company stores don’t undercut independents, but instead create something of a ceiling on prices from which independents can safely discount, Bell says.

But in setting these high prices, manufacturers could be walking a fine line. There’s controversy surrounding a practice called “resale price maintenance,” Bell notes, in which manufacturers elicit retail prices that are higher than what independents would set if acting alone. Manufacturers, he adds, attempt to achieve RPM through contractual means — using, for example, a specific set of rules or clauses that prohibit the retailer from selling at very low prices, and threatening to terminate distribution if the retailer doesn’t agree. It is a way for the two parties to help recover the costs of distribution and avoid excessive price cutting at the retail level.

The practice was illegal until 2007. But research shows that manufacturers with company stores influence the market in ways that go beyond merely the price charged for products. Independents competing against a manufacturer-owned store spend more on marketing, the research shows, than they otherwise would. That’s because they are less concerned about “horizontal free-riding,” Bell says, in which consumers visit the store that offers the best service to learn about products, but then buy from the lower-price competitor. Without the company store to set a high standard in marketing, “no one is willing to put the effort in, and they just compete on price.”

“If the threat of free-riding undermines brand-enhancing activities by retailers … manufacturers can be hurt,” the researchers write. “Neither price squeezing nor explicit resale price maintenance need occur in the company store channel. Rather, when consumer demand is affected by the store’s own efforts and competitor marketing efforts at the retail level, it is possible to find ‘complementary’ benefits for both parties.”

Company stores are probably most helpful for manufacturers that want to maintain more of a luxury or status image for their products, Bell says. And there are most likely other ways the company store channel can affect the retail market. More research is needed not only because of growth in the number of manufacturer-owned stores, Bell says, but also because company stores and independent retailers are all co-located on the Internet.

For now, the moves by manufacturers into the world of bricks-and-mortar retailing arguably are the most interesting parts of the trend to watch. Bell points to the example of Siam Cement Group, a huge business-to-business conglomerate in Asia that has just opened a “concept store” in a wealthy suburb of Bangkok. In that case, the manufacturer is trying to directly reach consumers who might select for their new homes some of Siam’s high-end bathroom equipment, tile and other building materials. “The place is amazing,” Bell says of the store. “It looks like a variant of the New York City Apple store on Fifth Avenue.”

As for Microsoft, the question remains whether the software giant’s stores will go the way of Apple or Gateway, another California-based computer company that gave retail a try, adds Bell. Gateway began its retail experiment in the 1990s, but it didn’t last — the company announced in 2004 that it was closing its network of 188 Gateway retail shops. Part of Gateway’s problem was that company stores primarily sold computers in boxes, and didn’t generate “sizzle” or an “experiential reason” to go there, Bell says.

Sizzle, however, clearly seems to be in Microsoft’s sights. The company store offers four “zones” that focus on different types of technology experiences, Microsoft said in a press release announcing the store’s October 22 debut. At the front of the shop, laptops are displayed on large cedar tables with seating that invites shoppers to play with the computers. Giant LCD screens line the walls and display landscapes and product images. Nearby, shoppers can gaze at stylish PCs outfitted with Zunes, Xbox consoles, headphones and widescreens. At the back of the store, Microsoft offers laptop bags and software titles, and then “a veritable bonanza for Xbox enthusiasts,” the company says, describing a gaming zone that features a 94-inch widescreen with seating and controllers so customers can play.

“It appears to be an impressive effort … that gives Microsoft an opportunity to have customers touch and feel a variety of their products, and also to leave feeling good about the brand experience,” Bell says. “One possible complication is, of course, how to allocate space and attention to the variety of vendors that build on the Microsoft platform. The potential for conflict with manufacturer and channel partners appears to be much greater than it is in the case of Apple and the Apple stores.”

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