In 2002, a jewelry retailer with its own online store as well, Ice.com, began offering its products for sale on Amazon.com through Amazon’s Marketplace service. The service allows outside companies to sell on Amazon pages for a monthly fee plus a cut of the sales revenue. Two years later, the retailer noticed something disconcerting.
Amazon—true to its strategy of offering everything from A to Z—had itself begun offering pearl necklaces and diamond earnings, some of Ice.com’s best-selling products. Suddenly, the jewelry merchant’s extra sales channel had become a sales competitor. It still is.
This situation exists for many companies that choose to sell products through their own, lesser-frequented websites and on Amazon, which attracts more than 100 million unique visitors a month, according to industry reports. This creates some vexing marketing issues.
Should a Web merchant sell on both sites or only one? And if only one, which one? From Amazon’s perspective, would the giant e-tailer make more money selling products without having competitors looming on its results pages, or does the company stand to make even more money through the combination of its own sales and the collection of rent and sales cuts from competitors?
A pair of Notre Dame management faculty, Daewon Sun and Xuying Zhao, set out to analyze the dynamics of this situation using game theory, which is a way of mathematically modeling conflict and cooperation among parties. The process assumes that all parties will act rationally. The professors say they are the first to study the dynamics of competition and cooperation in such online marketplaces.
In their recent paper, written with co-researcher Jennifer K. Ryan of Rensselaer Polytechnic Institute, they conclude that each party’s path to profit maximization depends on its strength relative to the other, but that a dominant marketplace entity, such as Amazon, holds almost all the cards.
If the outside merchant is well known in the market for a particular product that Amazon is trying to sell, and if the merchant’s own website is highly regarded and trusted, then Amazon would be better off sharing space on its site with the competitor, they say, because the
opportunity cost to Amazon of sharing space is relatively low.
But if Amazon (or any other online merchant offering a marketplace system, such as Sears) held a stronger position in the market for that product, then it should freeze out the competition, according to the researchers. Legally, Amazon could not simply exclude some merchants and accept others offering the same product; it would have to offer the same terms to all, says Zhao. But it could demand such high monthly fees and revenue shares for listing the product that it would scare off all competition.
The researchers’ paper, “Competition and Coordination in Online Marketplaces,” appears in the March 11, 2012, issue of the journal Production and Operations Management.