This paper attempts to model the strategic interaction between firms in online and traditional markets. It analyzes how each market affects the competitive characteristics of the other. Existing research on electronic markets has focused largely on their welfareenhancing features. However, electronic markets coexist with traditional markets with each strongly influencing the other. Results show that the profits of firms in competing channels increase as they differentiate themselves as much as possible from each other, and by differentiating themselves based on the characteristics over which consumers have the maximum variety in relative valuations. The choice of the factors of differentiation, however, is crucial, as are the relative sizes of the online and offline markets. The results also indicate that neglecting the impact of traditional markets on online firms risks oversimplification, and might lead to incorrect prescriptions to both offline and online firms.