Abstract

Existing research on electronic markets has focused largely on analyzing their efficiency and welfare- enhancing properties, treating these markets as isolated entities. In reality, however, electronic markets coexist with traditional, land-based firms. They compete not only with similar rivals, but also with firms with different competencies, information technology, channel characteristics, and business cultures. The interaction between these different firms involves complex and interesting competitive dynamics, which cannot be captured by isolated models of electronic markets. This paper models competition between firms that sell their products purely through electronic channels, firms whose primary retailing outlets are traditional land-based channels, and hybrid firms—those selling both off- line and online. A game-theoretic spatial differentiation model is used to analyze the impact of the coexistence of new, emerging technology-driven distribution channels with conventional retail channels, and the possible strategic interactions between these two vastly different retail environments. The features of market equilibria, and their sensitivity to different technological and channel parameters are studied, and the results of the model are compared with the benchmark case where the electronic markets are independent of traditional markets. 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 offline, online, and hybrid firms.

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