AH focuses on the endogenous quality decision on ENC. It extends A’s 07 model with the consumer heterogeneity on quality, so that M can quality differentiate (QD).
In the canonical setup, it is well-known that QD reduces end market competition and thus increases the profits of all firms. When M can operate dual channels, however, the issue is more involved.
That is because now M has three levers—the wholesale price, the direct sell quantity, and the quality. The quality level gives M more flexibility. First, he can use the quality to stimulate demand directly, instead of using the wholesale price indirectly. Second, he can use the quality to differentiate two channels, to soften the downstream competition.
Associated with the three levers are three effects. First, the competition effect: because the retail and direct channels compete directly in the end market, the retailer may lose, when M shifts the demand to the direct channel. Second, the wholesale price effect: M may reduce the wholesale price to boot the retailer demand (positive effect). Third, the quality adjustment effect: M may use quality to stimulate demand directly (hinged on the assumption that the price ).
Depending on the selling cost and the production cost (convex in quality) , the three effects can create different outcomes, e.g., win-win, win-lose, lose-lose, and lose-win.
Anyway, I am not impressed.
[INSIDE PARADISE INN, MOUNT RAINIER, 9/2015]