The Downside of Reorder Flexibility under Price Competition

40 Pages Posted: 27 Dec 2011 Last revised: 2 Dec 2019

See all articles by Philipp Afeche

Philipp Afeche

University of Toronto - Rotman School of Management

Ming Hu

University of Toronto - Rotman School of Management

Yang Li

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Date Written: November 26, 2019

Abstract

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

Suggested Citation

Afeche, Philipp and Hu, Ming and Li, Yang, The Downside of Reorder Flexibility under Price Competition (November 26, 2019). Available at SSRN: https://ssrn.com/abstract=1976886 or http://dx.doi.org/10.2139/ssrn.1976886

Philipp Afeche

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-978-1591 (Phone)

HOME PAGE: http://www.rotman.utoronto.ca/facbios/viewFac.asp?facultyID=philipp.afeche

Ming Hu

University of Toronto - Rotman School of Management ( email )

105 St. George st
Toronto, ON M5S 3E6
Canada
416-946-5207 (Phone)

HOME PAGE: http://ming.hu

Yang Li (Contact Author)

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Hong Kong, N.T.
Hong Kong

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