The Role of Product Quality in Marketplaces

Problem definition: Online retailers who operated as traditional resellers have also started to adopt the marketplace approach, wherein the retailer charges a commission, and the suppliers determine the retail price. We model the interactions between a retailer and two suppliers, who offer products of differing qualities, face loyal consumers, and enjoy quality- and price-dependent demand functions. We identify what contract type—only marketplace, only wholesale, or a combination of marketplace and wholesale (i.e., hybrid)—will prevail. Methodology/results: In contrast to marketplace’s dominance when there is a single supplier, depending on the heterogeneity in the suppliers’ product quality, operating only a marketplace may result in either a suboptimal commission rate or the exclusion of the supplier offering the high-quality product from the contract. We find that the retailer may then choose a hybrid contract to better tailor the contract to each supplier type. We show that the hybrid contract can emerge under four realistic scenarios: when suppliers determine quality level endogenously; suppliers select the contract type; the retailer is dominant and proposes tiered commission rates; and a continuum of supplier types. Moreover, in all these cases, when the hybrid contract is adopted, the lower quality product is sold via marketplace, whereas the higher quality product is sold via wholesale. Using data from a leading U.S.-based retailer, we also provide empirical support for this specific equilibrium outcome. Managerial implications: Our findings provide guidance to retail managers who are transitioning into marketplaces on when and what type of hybrid contract would be advisable to offer. By introducing heterogeneity in the suppliers’ product quality, our work also contributes to the literature by uncovering new driving forces for why the hybrid contract emerges as an equilibrium outcome. Funding: A. Jain’s work on this research was supported by Professional Staff Congress - the City University of New York Award jointly funded by The Professional Staff Congress and The City University of New York. Supplemental Material: The online appendix is available at https://doi.org/10.1287/msom.2024.0921 .