Dual Distribution Channels: The Competition Between Rental Agencies and Dealers
Authors: Purohit Devavrat 
Published: October 2008

Managerial decisions involving marketing channels are among the most critical that an organization must make. Part of the reason for this importance is that relationships between manufacturers and their intermediaries usually involve long-term commitments that are difficult to change. On the other hand, in order to respond to the realities of the market place, an organization must be ready to adapt its distribution practices—sometimes under considerable uncertainty about the long-term consequences. Such a problem faces the U.S. automobile industry, which has led manufacturers to experiment with various channel structures. When manufacturers first changed their distribution policies, they were clear about the short-term effect on sales, but were unsure about its longer term impact on profitability. In this article, we develop a model to analyze the marketing of durable products through multiple channels. Our analysis suggests that, even though it was not apparent at the time, manufacturers were indeed behaving optimally when they changed their policies. Our model provides insights not only to automobile manufacturers but also to practitioners and academics who are interested in understanding the unique problems associated with marketing durable products through multiple channels.

We develop a two-period model by assuming that a single manufacturer markets a durable product through two retailers—a rental agency and a dealer. The rental agency focuses mainly on renting the product in a daily rental market while the dealer focuses on selling the product to a different set of customers in the sales market. To model the development of channels in the U.S. automobile industry, we analyze three different channel structures. The first structure, a separate channel, reflects the state of the industry through most of the 1980s, when rental agencies were franchised solely to rent and dealers solely to sell the cars. In response to a decrease in overall sales, manufacturers encouraged rental agencies to sell their “slightly used” rental cars in the consumer market, resulting in the second structure, an overlapping channel. Dealers did not like this arrangement, however, and in the next experiment, a buyback channel, some manufacturers began buying back used rental cars and selling them through dealers.

In terms of the consumer side of the model, we assume that consumers are heterogeneous and have product valuations that are distributed uniformly between a low and a high value. In addition, they recognize that as the durable depreciates with use, its secondhand market value decreases. While both sold and rented goods depreciate with use, we assume, based on an analysis of market prices, that sold goods depreciate at a higher rate than rented goods. Given these different depreciation rates and consumers' underlying utility functions, we develop the market demand functions in the dealer's and rental agency's markets. Then for each of the channel structures, we solve the intermediaries' and manufacturer's problems.

The main contribution of this article is that it allows us to evaluate the profitability associated with various channel structures for all the players in our analysis—the dealer, the rental agency, and the manufacturer. In terms of the intermediaries, we find that the overlapping channel is the most profitable structure for the rental agency; on the other hand, it is the least profitable for the dealer. In terms of manufacturer profitability, our model suggests that the separate channel is the least profitable, and the overlapping channel is the most profitable. It is interesting to note that the distribution structure in existence today is more akin to a buyback channel. This strikes us as a compromise channel, which alleviates dealer concerns with the overlapping channel, and yet does not harm rental agencies as much as a separate channel. These are surprising results because conventional wisdom has been that the overlapping channel was competing away profits for all players. This suggests to us that automobile manufacturers were indeed on the right track when they began experimenting with the structure of their distribution channels.