Strategic Segmentation Using Outlet Malls

An important phenomenon in recent years has been the growth of low-service manufacturer-operated stores in malls located a significant distance from the shopping districts of major metropolitan areas. For the most part, these "outlet" stores offer minimial service, attractive pricing and a full product line. However, the "outlet" store phenomenon is not universal and there are a number of categories where manufacturers restrict their distribution to primary retailers. Our objective is to provide a rationale for the popularity of outlet stores in some categories and the absence of outlet stores in others. We build an analytical model with two manufacturers that distribute (a) through primary retailers or (b) with dual distribution (through primary retailers and outlet malls). The manufacturers compete in a market of buyers that are heterogeneous in terms of price and service sensitivity. The motivation for dual or segmented distribution is certainly related to differences between consumers. However, the attractiveness of retailing through outlet stores and through primary retailers is not a straightforward function of the degree to which consumers are different. It is related to how consumers are different. In particular, when the range of service sensitivity across consumers is high relative to the range of price sensitivity, manufacturers will find that single channel distribution is superior. When the opposite is true, manufacturers have higher profits in a market where dual distribution with outlet stores is utilized. This key result holds because outlet malls attract price-sensitive, non-service-sensitive consumers, leaving more service-sensitive (and less price-sensitive) consumers in the primary market. Decreasing the sensitivity of demand to price in the primary market is a welcome result if and only if the consumers who stay in the primary market are not overly sensitive to service. In sum, the model demonstrates both the value and the danger of segmentation under competitive conditions.