The Downside of Reorder Flexibility under Price Competition
40 Pages Posted: 27 Dec 2011 Last revised: 2 Dec 2019
Date Written: November 26, 2019
Problem definition: Reorder flexibility allows firms to better match supply with unpredictable demand for products with short selling seasons. We study how competition affects the flexibility choices, inventory and pricing decisions, and profits of duopoly firms, assuming that price competition determines equilibrium prices.
Academic/practical relevance: Reorder flexibility is increasingly relevant in practice. The operations literature shows that reorder flexibility increases profits under competition, assuming fixed prices or quantity competition. Our model of price competition offers an alternative perspective, motivated by nearshoring trends and technological advances that foster "near-frictionless" resupply conditions, and our results uncover significant caveats to the benefits of reorder flexibility reported so far.
Methodology: We solve a three-stage game-theoretic model of symmetric duopoly firms that sell differentiated products with stochastic price-sensitive demand. Firms first make reorder-flexibility decisions; then place initial orders before observing demand; then, after observing demand, simultaneously choose prices and, if they have the option, reorder quantities at a higher unit cost. Price competition complicates the analysis of initial order equilibria as the relevant payoff functions are not unimodal.
Results: (i) The firms' equilibrium flexibility strategies are symmetric. (ii) Reorder flexibility may hurt profits and increase initial orders. (iii) Reorder flexibility only improves profits if it reduces initial orders and in addition, demand variability is moderate, reordering is sufficiently inexpensive, and products are sufficiently differentiated. (iv) Otherwise, firms may be trapped in a prisoner's dilemma, where reorder flexibility is their dominant strategy even though it hurts their profits.
Managerial implications: Our results suggest that reorder flexibility and product differentiation must be viewed and managed as complementary capabilities: To enjoy the benefits and avoid the downside of reorder flexibility in competitive environments, firms need to differentiate their products sufficiently and embrace the operational changes and investments required to keep the cost of reorder flexibility low.
Keywords: Reorder flexibility, price/inventory competition, quick response, seasonal products, supply chain/marketing interface, volume flexibility
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