Integrated Management of Inventory, Labor and Financing under Negative Demand Shock

Abstract

In this study, we examine how a retailer can manage capital, inventories, and labor under an extreme condition such as a temporary negative demand shock due to a pandemic or an economic turmoil. We assume that both the labor and capital markets are imperfect and trading in those markets is subject to different degrees of labor and capital market frictions. Our study assesses the impact of these frictions on a retail firm's optimal operating policies around inventory level, furlough, and layoffs. We also examine the impact of public policies, such as CARES act and Shared Work programs, within such retail contexts. We find that labor market frictions condition the inventory and the level of employment in two ways. First, they lead to underinvestment in inventories, which limits recovery and employment in the post-shock period. Second, high labor market frictions motivate the firm to partially downsize workforce during the negative demand period leading to higher employment, when compared to downsizing without friction. The net impact of labor market frictions on labor and inventories depends on whether these factors are complements or substitutes. The presence of capital market frictions, in addition to labor market frictions, amplifies underinvestment in inventories and reduces total employment. We document the relative performance impacts for governmental policies during demand shock period that support furloughing labor to mitigate the impact of labor and capital market frictions on employment and profits.

Keywords: Capital market frictions, labor market frictions, retail, inventory, negative demand shock