When Customers Anticipate Liquidation Sales: Managing Operations under Financial Distress

Manufacturing & Service Operations Management, Forthcoming

39 Pages Posted: 30 Aug 2015 Last revised: 16 Jan 2017

See all articles by John R. Birge

John R. Birge

University of Chicago - Booth School of Business

Rodney P. Parker

Indiana University Bloomington

Michelle X. Wu

Massachusetts Institute of Technology (MIT) - Institute for Data, Systems, and Society (IDSS); Carson College of Business, Washington State University

S. Alex Yang

London Business School; The University of Hong Kong - Faculty of Business and Economics

Date Written: December 3, 2016

Abstract

The presence of strategic customers may force an already financially distressed firm into a death spiral: Sensing the firm's financial difficulty, customers may wait strategically for deep discounts in liquidation sales. In turn, such waiting lowers the firm's profitability and increases the firm's bankruptcy risk. Using a two-period model to capture these dynamics, this paper identifies customers' strategic waiting behavior as a source of a firm's cost of financial distress. We also find that customers' anticipation of bankruptcy can be self-fullling: When customers anticipate a high bankruptcy probability, they prefer to delay their purchases, making the firm more likely to go bankrupt than when customers anticipate a low probability of bankruptcy. Such behavior has important operational and financial implications. First, the firm acts more conservatively when either facing more severe financial distress or a large share of strategic customers. As its financial situation deteriorates, the firm lowers inventory alone when financial distress is mild or only a small share of customers are strategic and lowers both inventory and price in the presence of severe financial distress and a large fraction of strategic customers. Under optimal price and inventory decisions, strategic waiting accounts for a large part of the firm's total cost of financial distress, although a larger proportion of strategic customers may result in a lower probability of bankruptcy. In addition to inventory reduction and (immediate) price discount, we find that a deferred discount, in the form of rebates and/or store credits for future purchases, can act as an effective mechanism to mitigate strategic waiting. As a contingent price reduction, deferred discounts align the interests of customers and the firm and are most effective when the fraction of strategic customers is high and the firm's financial distress is at a medium level.

Appendix is available here: http://ssrn.com/abstract=2896581.

Keywords: financial distress; liquidation sale; strategic customers; inventory; pricing; deferred discount; rebate; deferred discount

Suggested Citation

Birge, John R. and Parker, Rodney P. and Wu, Michelle X. and Yang, S. Alex, When Customers Anticipate Liquidation Sales: Managing Operations under Financial Distress (December 3, 2016). Manufacturing & Service Operations Management, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2652994 or http://dx.doi.org/10.2139/ssrn.2652994

John R. Birge

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Rodney P. Parker

Indiana University Bloomington ( email )

1309 E 10th Street, HH4129
Bloomington, IN 47405
United States

Michelle X. Wu

Massachusetts Institute of Technology (MIT) - Institute for Data, Systems, and Society (IDSS) ( email )

United States

Carson College of Business, Washington State University

Wilson Rd.
College of Business
Pullman, WA 99164
United States

S. Alex Yang (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

HOME PAGE: http://faculty.london.edu/sayang/

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

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