AI and Analytics for Business

Research Paper Series

Demand Expansion and Cannibalization Effects From Retail Store Entry: A Structural Analysis of Multi-Channel Demand

For a multi-channel retailer, opening a physical store can lead to cannibalization of online sales as consumers’ transportation costs decrease. Holding purchase frequency fixed, this channel switching behavior represents an economic loss to the firm if customers buy fewer or lower margin items in retail stores. However, greater proximity to a retail outlet may increase consumer awareness and consideration of the brand, leading to higher purchase frequencies across channels. In this paper, we devise and estimate a structural model to separately identify the effects of customer-to-store distance on channel switching and brand consideration. Our direct utility framework models outcomes at the level of individual purchase occasions and captures heterogeneous preferences for multiple channels and product categories. Our identification strategy exploits within-customer variation in distance resulting from store entry during a period of rapid retail expansion. We find that retail entry induces channel switching behavior but also leads to greater consideration of the brand. Our estimates imply a 10% reduction in retail store distance increases retail channel expenditures by 2.1% and decreases online channel expenditures by 0.6%, resulting in a 0.8% increase in total expenditures. Through counterfactual experiments, we demonstrate that retail expansion can ultimately limit the ability of the firm to price discriminate across channels, since reducing transportation costs weakens the firm’s ability to enforce channel-based segmentation schemes. Retail expansion remains profitable in our setting, where revenue gains from the demand-expanding effect of entry on brand consideration exceed revenue losses resulting from consumers switching to the lower cost retail channel.

Keywords: Channels of distribution, pricing, discrete-continuous models, market entry