Strategic Inventories in Vertical Contracts

Abstract

Classical reasons for carrying inventory include fixed (nonlinear) production or procurement costs, lead times, nonstationary or uncertain supply/demand, and capacity constraints. The last decade has seen active research in supply chain coordination focusing on the role of incentive contracts to achieve first-best levels of inventory. An extensive literature in industrial organization that studies incentives for vertical controls largely ignores the effect of inventories. Does the ability to carry inventory influence the problem of vertical control? Conversely, can inventories arise purely due to incentive effects? This paper explicitly considers both incentives and inventories, and their interplay, in a dynamic model of an upstream firm (supplier) and a downstream firm (buyer) who can carry inventories. In our model, none of the classical reasons for carrying inventory exists. However, as we prove, the buyer's optimal strategy in equilibrium is to carry inventories, and the supplier is unable to prevent this. These inventories arise out of purely strategic considerations not yet identified in the literature, and have a significant impact on the equilibrium solution as well as supplier, buyer, and channel profits. We prove that strategic inventories play a pivotal role under arbitrary contractual structures, general (arbitrary) demand functions and general (finite or infinite) horizon lengths. As one example, two-part tariff contracts do not lead to optimal channel performance, nor can the supplier extract away all of the channel profits, in our dynamic model. Our results imply that firms can and must carry inventories strategically, and that optimal vertical contracts must take the possibility of inventories into account.contracts, inventories, industrial organization, supply chain coordination

The Impact of Demand Uncertainty on Consumer Subsidies for Green Technology Adoption

“…Examples include Anand et al (2008) and Erhun et al (2011) and the references therein. These papers study supply chain contracts where the treatment mainly focuses on linear inverse demand curves.…”

Distribution channel strategies in a mixed market

“…Within each competition mode, we consider two standard vertical contracts, wholesale-price and two-part tariff contracts, both common in practice (Cachon, 2003;Anand et al, 2008). Wholesale-price contracts are popular mainly due to simplicity, but result in low efficiency in supply chains.…”

Strategic Inventories under Limited Commitment

“…The difference between the quantity produced and the sales in each period determines the producer's inventories available for sale in the following period. In line with the relevant literature (e.g., Anand et al 2008;Arvan 1985;Arya et al 2015;Arya and Mittendorf 2013;Mitraille and Moreaux 2013;Mollgaard et al 2000;Krishnan and Winter 2010;Ware 1985), production and inventory decisions are observable and can therefore affect the buyer stockpiling behavior. As discussed in the 10 This cost formulation isolates the strategic inventory incentives under investigation and neutralizes further possible inventory reasons.…”

“…Anand et al (2008) show that in a dynamic buyer-seller relationship the buyer uses strategic inventories to induce the seller to decrease its future price.…”

“…Extending the model of Anand et al (2008), Arya and Mittendorf (2013) investigate the role of consumer rebates in the presence of strategic inventories, while Arya et al (2015) find that strategic inventories influence the choice between centralization and decentralization. Hartwig et al (2015) provide experimental support for strategic inventories.…”