Competition on Inventory Availability and Price Under Customer Heterogeneity
48 Pages Posted: 6 Dec 2018 Last revised: 15 Apr 2019
Date Written: April 14, 2019
Inventory availability has been widely recognized as an important leverage to enhance the competitive edge of a firm. This paper develops an integrated newsvendor and Salop’s circle model to study the competition between retailers under customer heterogeneity. The retailers make decisions on their prices and stocking quantities; customers do not observe the inventory information but prices, and thus have to form beliefs about the availability probabilities through the open price information. We analyze the strategic interaction between the retailers and customers, and draw the following insights. First, contrary to intuition, the retailers may charge a higher price under more intense competition. A high price signals high product availability, thus facilitating the retailer to attract more customers in the presence of competition. It is well known that strategies like monetary compensation and inventory commitment can mitigate strategic customer behavior and thus improve a monopoly retailer’s profit. In a competitive market, however, both monetary compensation and inventory availability would lead to a prisoner’s dilemma. Although these strategies are preferred regardless of the competitor’s price and inventory decisions, the equilibrium profit of each retailer is lower in the presence of monetary compensation or inventory commitment because they would intensify the competition between retailers. In contrast to the widely held belief that market competition improves customer surplus in general, it may hurt customers in our setting. This is because competition may drive the retailers to charge higher prices to signal higher inventory availability. We also show that monetary compensation and inventory commitment provide incentives for customers to patronize the retailers, thus mitigating the customer surplus loss caused by competition.
Keywords: Inventory availability, retail competition, strategic customer behavior, newsvendor, Salop circle
Suggested Citation: Suggested Citation