Friday, February 15, 2019

Competition on Inventory Availability and Price Under Customer Heterogeneity

Junfei Lei, University of Washington - Department of Information Systems and Operations Management, Yugang Yu, University of Science and Technology of China (USTC), Fuqiang Zhang, Washington University in St. Louis - John M. Olin Business School, Renyu (Philip) Zhang, New York University Shanghai study Competition on Inventory Availability and Price Under Customer Heterogeneity.

ABSTRACT: Inventory availability has been widely recognized as an important leverage to enhance the competitive edge of a firm. This paper develops an integrated newsvendor and Hotelling model to study the competition between two retailers under customer heterogeneity. The retailers make decisions on their prices and stocking quantities; customers do not observe the inventory information of the retailers, and thus have to form beliefs about the availability probabilities. We analyze the strategic interactions between the retailers and customers, and draw the following insights. First, contrary to intuition, the retailers may charge a higher price under competition than in the monopoly setting. A high price signals high product availability, thus facilitating the retailer to attract more customers in the presence of competition. It is well known that strategies like monetary compensation and inventory commitment can mitigate strategic customer behavior and improve a monopoly retailer’s profit. In a competitive market, however, both monetary compensation and inventory availability would lead to a prisoner’s dilemma. Although these strategies are preferred regardless of the competitor’s price and inventory decisions, the equilibrium profit of each retailer is lower in the presence of monetary compensation or inventory commitment because either strategy would intensify the competition between retailers. In contrast to the widely held belief that market competition improves customer surplus in general, it may hurt customers in our setting. This is because competition may drive the retailers to charge higher prices to signal inventory availabilities. We also show that monetary compensation and inventory commitment strategies provide incentives for customers to patronize the retailers, thus mitigating the customer surplus loss caused by competition.

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