Abstract

E-commerce retailing pioneers started to display the links of competitors’ products directly on their web pages to generate revenues through revenue sharing mechanisms. A retailer may choose a one-way referral contract, choose a mutual referral contract, or stay independent depending on the market condition. We investigate how the degree of product vertical differentiation will affect the adoption of in-store referrals. When two retailers have different compositions of the products regarding quality, one may choose to refer the products of its competitor or not. By studying two competing retailers having heterogeneous product qualities in a game-theoretic manner, we examine how product quality and revenue sharing ratio influence the retailers’ optimal contract design in terms of in-store direct referrals. We find that referrals may be mutually beneficial and thus exist in a market equilibrium. Moreover, the low-quality retailer has more incentives to refer the high-quality product. Nevertheless, when the quality difference is small enough, no referral will take place in a market equilibrium. We also show that it is more likely for referral to be mutually beneficial if the revenue sharing ratio is high.

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