Inventory Management in Markets with Search Frictions

Abstract

We present a directed search model of intermediaries with dynamic inventory and revenue management. Buyers purchase goods produced by sellers through intermediaries. Search frictions create demand uncertainty and make instantaneous replenishment impossible. To avoid the risk of stock-out, intermediaries hold inventory and employ inventory-based pricing and ordering policies. In equilibrium, when inventory is high, the intermediary posts a lower retail price to speed up sales and depresses wholesale price to slow down purchases, generating unimodal steady-state distributions of both inventory holdings and retail prices. Using a dataset that contains detailed information on used-car listings, we examine the dynamics of car dealers' inventories, new orders, sales, and retail prices and find evidence supporting the theory. We calibrate the model and show that (i) the proposed mechanism can generate a substantial amount of observed price dispersion, and (ii) our calibration attributes a substantial proportion of intermediaries' value to inventory management.

Keywords: Directed Search, Inventory Management, Revenue Management, Price Dispersion, Used Car, Dealers, Intermediary

JEL Classification: D82, D83, L15, L62