Abstract: With the rapid development of the Internet, manufacturers are increasingly adopting a dual-channel approach to selling products, (i.e., a traditional retail channel and an online direct channel). Consequently, consumers can experience a product in a brick-and-mortar store while shopping online for the cheapest price. Using the two-stage optimization technique and the Stackelberg game, we examine the impact of consumer free-riding on sales effort and prices in a centralized and a decentralized dual-channel supply chain. We find that both the sales effort and the whole supply chain profit are much lower in the decentralized setting than in the centralized setting. Moreover, the sales effort and the whole supply chain profit decrease as the rate of free-riding increases in both centralized and decentralized settings. In order to improve supply chain efficiency, we propose a certain cost-sharing contract. This contract is proved to lead to a Pareto improvement for both supply chain partners. The numerical study demonstrates how the proposed contract is applied as well as how it improves supply chain efficiency.

Key words: dual-channel supply chain, sales effort, consumer free-riding, cost-sharing contract