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PRICING STRATEGIES OF ONLINE RETAILERS: Applicability of Porter’s model of generic strategies

The United States Supreme Court made a decision in 2007 which provided a greater tolerance for vertical resale price maintenance (RPM). A vertical RPM is a minimum price maintenance agreement in which a manufacturer maintains a price floor at which distributors or retailers might sell their product. Since this vertical minimum RPM agreement, it is possible that online retailers might refrain from using their low-cost structure to underprice their competition.

Applicability of Porter’s model of generic strategies in the context of online retailers is examined post the court’s decision. Porter has stated five generic strategies which a business could follow so as to gain a competitive advantage over its competitors. These five strategies consist of three basic classifications: cost leadership, differentiation, and focus.

To protect trade and commerce against unlawful restraints, the Sherman Antitrust Act was passed in 1890. It helps in consumer protection by prohibiting any vertical restraint which can affect the consumers negatively. The purpose of this Act was to reduce restraints on trade that affected productivity and put pressure on consumer prices. However, since past, US Supreme court opposed minimum price maintenance agreements since they lead to the formation of cartels etc., but in 2007, they reversed their opinion on it.

The research paper has analyzed the case of Leegin Creative Leather Products v. PSKS, Inc. Leegin was a manufacturer of consumer goods and PSKS was one of their retailers. Leegin usually suggested retail prices for the manufactured products but PSKS set a retail price for these products lower than Leegin’s suggested retail price. As a result, Leegin discontinued selling its products to PSKS which is why PSKS filed a lawsuit against them. It was centered on the fact that whether the minimum price control agreement led to an unreasonable restraint on trade and thus was a violation of the Sherman Antitrust Act. Following this, the Supreme Court issued the Leegin holding supporting the minimum resale price maintenance agreements.

Initially, online retailers used to engage in cost leadership strategy in which they competed on the basis of price. This was because online retailers would incur fewer transaction costs than brick-and-mortar business as the internet market has less friction. However, after US Supreme Court’s hearing, they will have to indulge in alternative competitive strategy. In reference to Porter’s generic strategies, ‘Cost leadership’ for online retailers meant low-cost strategy given their less operating costs. After the Leegin holding, due to minimum price maintenance agreements, low costs will not help the online retailer in competing with brick-and-mortar businesses, since even they have to face the same restraints as traditional firms related to price.

In reference to ‘differentiation’, businesses used to follow either a differentiation or focus strategy. However, even after the Leegin holding, the online retailers can still differentiate its products by non-price measures like enhanced website, online brand recognition, providing better services and thus reduce consequences of a minimum price maintenance agreement. In terms of ‘focus’ strategy, it meant that business focus resources on few markets to increase brand loyalty and customer satisfaction. They can still pursue this even after the Leegin holding by focusing the marketing mix on the narrowly defined target markets.

To reduce the impact of minimum price requirement, online retailers can indulge in integrated strategy, which combines both cost leadership and differentiation strategies of Porter’s model of generic strategies. An added benefit to this will be the scalability of the internet. An integrated strategy will help to position the online retailer as an innovative customer service by providing differentiated products and services like brand offerings, extensive inventory, ease of online access and use, competitive pricing, user-friendly interface and non-price benefits like free shipping etc.

As minimum RPM agreements are permitted now, manufacturers gain power over retailers as it related to the resale price of their product. It means that a profit margin is set for wholesalers and retailers. Thus it can be seen that even though the minimum price agreement creates challenges for the online retailers, there are alternative strategies that they should explore to compensate for the loss. The internet retail environment has many potential benefits and exploring them will certainly help the online retailers emerge successfully.