Group Buying Commitment and Sellers’ Competitive Advantages

• Date: 01 March 2013
• DOI: http://doi.org/10.1111/jems.12000
• Published date: 01 March 2013

Group Buying Commitment and Sellers’

Competitive Advantages

YUXIN CHEN

Kellogg School of Management

Northwestern University

2001 Sheridan Rd.

Evanston, IL 60208

yuxin-chen@kellogg.northwestern.edu

XINXIN LI

School of Business

University of Connecticut

2100 Hillside Rd.

Storrs, CT 06269

xli@business.uconn.edu

This paper examines a model of duopoly firms selling to an exogenously formed buyer group

consisting of members with heterogeneous preferences. Two research questions are addressed: (1)

when is it optimal for a buyer group to commit to exclusive purchase from a single seller,and (2)

how does the presence of group buying and the exclusive purchase commitment associated with

it affect firms’ incentives to invest in quality improvement? We find that, even though exclusive

purchase commitment benefits buyers when the competing products provide similar quality,

it may lower buyer surplus if one product is significantly advantaged and/or the competing

products are not highly differentiated horizontally. This result is robust even if the buyer group

is formed endogenously. In addition, contingent on the similarity between the competing sellers’

investment costs, the sellers’ incentives to improve quality may be positively or negatively affected

by the presence of group buying.

1. Introduction

Buyers may purchase as groups in order to obtain favorable deals from sellers. For

example, employees in large companies and organizations usually purchase various

products and services as groups through their employers.1Group buying not only has

important implications to suppliers, procuring companies, and group members, but also

plays an important role in the whole economy. In 2007, over 177 million people purchased

health insurance as groups through their employers (DeNavas-Waltet al., 2008). In 2009,

92 million workers in the United States saved through employer-managed retirement

plans (SPARK, 2009).2A large number of buyer alliances also exist in various industries

The authors are listed alphabetically and contributed equally to the paper.The authors thank the coeditor and

two anonymous reviewers for valuable comments and suggestions. Yuxin Chen is currently visiting China

Europe International Business School as a Zhongkun Group VisitingChair Professor of Marketing.

1. Examples include health insurance packages (Enthoven, 1993), retirement plans (Dulebohn, 2002), IT

hardware (Greenstein, 1993), software(Hunt and Westfall, 2003), telecommunication equipment (Bruno-Britz,

2008), airline tickets, and hotels.

2. “The Case for Employer-Sponsored Retirement Plans—Coverage, Participation and Retirement Secu-

rity,”The SPARK Institute, Inc., May 2009.

C

2013 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume22, Number 1, Spring 2013, 164–183

Group Buying and Competitive Advantage 165

and across different countries for the purpose of negotiating lower prices from suppliers

(Chae and Heidhues, 2004).

A critical decision for a buyer group facing competing sellers to make is whether

to commit to exclusive purchase from a single seller, as the power of a buyer group

not only comes from its size but also from its ability to make such an commitment

(Dana, 2012). Committing to exclusive purchase consolidates demand and may intensify

seller competition. On the other hand, purchasing exclusively from a single seller

may compromise buyers’ heterogeneous preferences. In reality, exclusive purchase

commitment is observed in some cases but not in others (Maxwell and Temin, 2002).

Large employers usually use one of the two procurement models (Galvin and Delbanco,

2005): the “industrial purchasing approach” in which they contract with a single seller

to provide products or services, or the “managed competition model” in which options

from multiple suppliers are presented to employees from which each employee makes

their own choices. Thus, an important question is when it is optimal for a buyer group

to commit to exclusive purchase.

To examine this research question, we develop and analyze a stylized model

with two asymmetric sellers competing for a group of heterogeneous buyers. We find

that exclusive purchase commitment is optimal only if neither seller has a significant

competitive advantage, that is, sellers are not too asymmetric in quality. This result

arises because the advantage of exclusive purchase commitment in inducing more

price competition among sellers diminishes when the asymmetry in sellers’ competitive

advantages grows. We also find that exclusive purchase commitment is more likely

to be optimal if sellers’ products are more horizontally differentiated. The reason is

that buyers, when purchasing individually, have to pay higher prices when sellers are

more horizontally differentiated. In this situation, the buyer group’s incentive to induce

additional price competition among sellers through exclusive purchase commitment

dominates the potential loss it suffers, as some members have to consume the less-

preferred product. We find these results to be robust when we extend our model to

allow the buyer group to form endogenously.

Wethen extend our basic model to incorporate sellers’ quality investment decisions

to examine: how will group buying affect sellers’ investments in quality improvement?

Weshow that with symmetric costs of quality improvement, sellers invest more in quality

improvement when buyers purchase as a group. Interestingly, the opposite result may

occur in the asymmetric case—with asymmetric costs of quality improvement, sellers

may invest less in quality improvement when buyers purchase as a group. The intuition

is that a weak competitor (i.e., the seller with higher cost of quality investment) may

find it optimal to maintain a large quality gap with its rival in order to discourage the

buyer group from purchasing exclusively.

Our research is closely related to the literature on exclusive dealing and group

buying.3

Within the exclusive dealing literature, O’Brien and Shaffer (1997) examine how

nonlinear pricing affects the incentives for market foreclosure when two manufacturers

contract with a monopolist retailer. One of their results suggests that the retailer always

3. Besides the papers that we discuss in details below,related research includes Chae and Heidhues (2004),

Chen (2003), Chipty and Snyder (1999), Dobson and Waterson (1997), Ellison and Snyder (2010), Horn and

Wolinsky (1988), Inderst (2007), Snyder (1996), (1998), Stole and Zwiebel (1996), and von Ungern-Sternberg

(1996). Although these studies focus on buyer size as the source of bargaining power, we examine how

committing to exclusive purchase may benefit a buyer group regardless of its size. There is also an emerging

literature on online group buying (Kauffmanand Wang, 2002; Anand and Aron, 2003; Jing and Xie, 2011). This

literature primarily examines sellers’ strategies but we focus on buyers’ decisions on group buying.