Inventory Commitment and Monetary Compensation under Competition

Abstract

Problem definition: Inventory commitment and monetary compensation are widely recognized as effective strategies in monopoly settings when customers are concerned about stockouts. To attract more customer traffic, a firm reveals its inventory availability information to customers before the sales season or offers monetary compensation to placate customers if the product is out of stock. This paper investigates these two strategies when retailers compete on both price and inventory availability. Methodology/results: We develop a game-theoretic framework to analyze the strategic interactions among the retailers and customers and draw the following insights. First, both inventory commitment and monetary compensation may 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 could be lower in the presence of inventory commitment or monetary compensation because they intensify the competition between the retailers. Second, we find that market competition may hurt social welfare compared with a centralized setting by reducing the product availability in equilibrium. The inventory commitment and monetary compensation strategies further intensify the competition between the retailers, therefore causing an even lower social welfare. Managerial implications: Our study shows that, although inventory commitment and monetary compensation improve retailers’ profit and social welfare under monopoly, these strategies should be used with caution under competition. Funding: F. Zhang is grateful for the financial support from the National Natural Science Foundation of China [Grants 71929201, 72131004]. R. Zhang is grateful for the financial support from the Hong Kong Research Grants Council General Research Fund [Grant 14502722] and the National Natural Science Foundation of China [Grant 72293560/72293565]. Y. Yu is grateful for the financial support from the National Natural Science Foundation of China [Grant 71921001]. Supplemental Material: The online appendix is available at https://doi.org/10.1287/msom.2021.0411 .