What type of contract should e-tailers offer sellers when facing internal competition

Abstract

This paper investigates whether an e-tailer should act as a platform and offer customers the product of a seller who can reach customers only through the e-tailer, and if so, what type of contract to offer the seller: a proportional commission based on revenue or a fixed fee per unit sold. The e-tailer also chooses the product line design: offer only her own product, offer only the outside seller’s product, or offer both her own product and the seller’s product. Intuitively, when the e-tailer’s product outperforms the seller’s product in terms of value-to-cost ratio, the e-tailer should not offer the seller’s product. However, non-intuitively, we also identify conditions in which the e-tailer remains better off not opening her platform to the seller even though the seller’s value-to-cost ratio is higher than the e-tailer’s and show how these conditions depends also on the consumers valuations. Regarding the type of contract to offer the seller, we find that most of the time, a proportional commission based on revenue is the best contract, guaranteeing the highest e-tailer profit. However, this is not always the case since there are situations when a fixed fee contract reduces the potential of internal competition.