Supply Chain Performance with Target-Oriented Firms

Abstract

Problem definition: We study a supply chain in which a supplier sets the wholesale price and a retailer responds with an order quantity. Both the two firms can be either risk-neutral—maximizing the expected profit—or target-oriented, which is to maximize her/his ability to reach a target profit.

Academic/Practical relevance: Our work not only sheds light on the benefit/loss of trading with target-oriented decision makers, but also adds new knowledge to the supply chain coordination literature.

Methodology: We provide a strong support for firms' target-based preference and the linear target formation model through a survey as well as analyzing company data. With the firms' target-oriented behavior evaluated by a CVaR-satisficing measure, we apply a game theoretical framework to investigate how the target-based preference affects supply chain performance.

Results: A firm, be it a supplier or a retailer, is always hurt by its target-based preference, but can benefit from its trading partner's target-based preference. A risk-neutral supplier, for example, can sometimes reap the whole supply chain's profit if the retailer is target-oriented; and a target-oriented supplier always performs better with a target-oriented retailer than a risk-neutral one. Furthermore, a target-oriented retailer or/and supplier can help alleviate the double marginalization effect, and with a specific target can help the supply chain achieve the same efficiency level as in a risk-neutral centralized system, with just a wholesale price contract. Another important finding is that if both firms are target-oriented, then the supply chain can have a higher expected profit under a decentralized system than a centralized one. This contrasts to the case when both firms are risk-neutral. We also investigate the role of outside option and retailer type misidentification, and find that both can alleviate the retailer's disadvantage of being target-oriented.

Managerial insights: i) the target-based preference can be exploited by the trading partner and hence a firm should adopt the target-oriented decision criterion with caution; ii) a target-oriented retailer can explore strategies such as revealing his outside option or hiding his target-based preference in order to be less manipulated; iii) whether a firm (and the supply chain) can benefit from its trading partner's target-based preference often depends on how ambitious the trading partner (and the firm itself if it is target-oriented) sets the target; iv) target-based preference of one or both firms can help the supply chain reach the first-best efficiency; and v) when both firms are target-oriented, decentralization can be preferred to centralization.

Keywords: target-oriented, target models, supply chain performance