With the rise of e-commerce, suppliers can now reach consumers directly through channels such as online platforms. On the surface, it might seem that this “encroachment” can only be detrimental to the traditional retail channel. However, HKUST’s Ying-ju Chen and colleagues reach a different conclusion. In important new work, they show that encroachment may benefit the retailer and hurt the supplier when product quality information is withheld.

In 2012, the mobile phone provider Huawei established a direct sales channel on an e-commerce platform and invested enormously in advertising to promote its new products. This is an example of encroachment, whereby a supplier not only sells via an intermediary and traditional independent retailers, but also sells directly to consumers via its own channel. “Now,” the researchers explain, “the supplier is not only a wholesale price charger but also a retail competitor.” From the perspective of the supplier, this is a viable strategy for increasing profit. For retailers, however, encroachment can intensify customer competition and cause pricing conflicts.

An important consideration when examining the effects of encroachment is the availability of information on product quality. Naturally, consumers are reluctant to purchase a product when they are unsure about its quality. This uncertainty can be reduced by disclosing private product information through tactics such as informative advertising, launching conferences, and labeling. “Because all these activities are costly,” say the researchers, “disclosure may be prevented by the supplier’s limited sales in a traditional retail sales channel.” Yet if the supplier establishes its own sales channel, the expanded market potential inspires more transparency.

Against this backdrop, the researchers explored the relationship between the level of information disclosure and channel structure. Adopting a classical encroachment framework, they constructed a mathematical model to assess how asymmetric information about product quality impacts profitability for both the supplier and retailer in an encroachment setting.

Strikingly, the authors found that retailers can actually benefit from encroachment via increased information transparency. “With encroachment,” explain the authors, “a retailer can enhance consumers’ product quality expectations by free riding on the supplier’s active disclosure behaviour.” In the case of Huawei, which spent approximately RMB9 million per month on advertising in 2016, retailers did not need to invest much while still reaping the rewards of this expensive advertising campaign.

Second, the results revealed that suppliers may in fact be harmed by encroachment when they fail to invest in information transparency. “Encroachment creates higher demand potential and thus requires the supplier to adopt a more active quality disclosure strategy,” explain the researchers. Failing to do so itself conveys negative information about product quality, reduces consumer purchasing, and hurts the supplier’s profitability.

These findings have crucial implications for today’s e-commerce market. First, the threat to retailers posed by encroachment might not be as real as once thought. Second, a supplier’s decision to set up a direct sales channel should not be made lightly—despite its potential to increase profits, encroachment can harm suppliers when necessary adjustments to information disclosure are not made. Simply put, “encroachment might benefit the retailer but hurt the supplier,” say the researchers.