Strategic Customer Behavior, Commitment, and Supply Chain Performance

Abstract:     
This paper studies the impact of strategic customer behavior on supply chain performance. We start with a newsvendor seller facing forward-looking customers. The seller initially charges a regular price but may salvage the leftover inventory at a lower salvage price after random demand is realized. Customers anticipate future sales and choose purchase timing to maximize their expected surplus. We characterize the rational expectations (RE) equilibrium, where we find that the seller's stocking level is lower than that in the classic model without strategic customers. We show that the seller's profit can be improved by promising that: either quantities available will be limited (quantity commitment) or prices will be kept high (price commitment). In most cases, both forms of commitment are not credible in a centralized supply chain with a single seller. However, decentralized supply chains can use contractual arrangements as indirect commitment devices to attain the desired outcomes with commitment. While decentralization has generally been associated with coordination problems, we present the contrasting view that disparate interests within a supply chain can actually improve overall supply chain performance. In particular, with strategic customer behavior, we find that: (i) a decentralized supply chain with a wholesale price contract may perform strictly better than a centralized supply chain; (ii) contracts widely studied in the supply chain coordination literature (e.g., markdown money, sales rebates, and buyback contracts) can serve as a commitment device as well as an incentive-coordinating device; and (iii) some of the above contracts cannot allocate profits arbitrarily between supply chain members due to strategic customer behavior.

Keywords: strategic customer behavior, newsvendor, rational expectations, commitment, supply chains, decentralization

JEL Classifications: D24, D84, L14, L23

Working Paper Series