Newsvendor Competition with Endogenous Biases

Abstract

Extensive studies have revealed that newsvendor decisions by human decision-makers are often biased by cognitive limitations, and, therefore, fail to achieve optimal profits prescribed by normative models. These biases are typically considered liabilities in individual inventory decision-making, and much research has focused on developing methods to debias the decision-maker—for example, by providing decision support tools. However, in competitive set- tings biases can provide a competitive advantage, such that a biased newsvendor may earn a higher profit than an unbiased one. This raises the question of whether and when firms should debias their decision-makers in such settings. In this paper, we analyze decision biases that are endogenous rather than exogenous in competing newsvendor games. Specifically, we develop a two-stage game theoretic model in which competing firms first select their decision-makers typefied by their bias levels, and then engage in a classic inventory competition game. Our analysis confirms the positive effect of the decision-maker’s bias on a firm’s economic outcome. However, this effect only appears in competitions in which decision biases are exogenously given. When biases are endogenously selected, firms are always (weakly) worse off than if they all had rational decision-makers. Our results suggest that debiasing at the industry level (e.g., adopting advanced inventory planning software) could benefit all players; however, individual firms do not have the incentive to do so in the absence of coordination mechanisms.

Keywords: behavioral operations management, newsvendor, decision bias, overoptimism, overprecision, reference dependence