The Downside of Reorder Flexibility under Price Competition
41 Pages Posted: 27 Dec 2011 Last revised: 9 Jul 2014
Date Written: July 8, 2014
The supply chain literature shows that reorder flexibility increases profits under competition, assuming fixed prices or quantity competition. We show that price competition, arguably a more appropriate price formation model in the presence of reorder flexibility, may yield opposite results. We consider a three-stage model of duopoly firms that sell differentiated products with stochastic demand. Firms make reorder-flexibility decisions and then place initial orders, before observing demand. After observing demand, firms set prices and, if they have the option, may reorder at a higher cost. We show that the expected profit functions are not unimodal and provide extensive equilibrium results. These appear to be the first for stochastic finite-horizon price-inventory competition with more than one order opportunity. We show: (i) Unilateral reorder flexibility is not an equilibrium; (ii) Reorder flexibility may increase initial orders; (iii) Reorder flexibility hurts profits except if it reduces initial orders and in addition, demand variability is moderate, reordering is sufficiently inexpensive, and products are sufficiently differentiated; and (iv) Firms can avoid the downside of reorder flexibility only in some cases where it hurts profits. In others, firms are trapped in a prisoner's dilemma, whereby reorder flexibility is the dominant strategy even though it hurts their profits.
Keywords: Price/inventory competition, quick response, seasonal products, supply chain/marketing interface, volume flexibility
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