Strategic Inventories Under Supply Chain Competition

Abstract

Problem definition: We consider the effects of strategic inventory (SI) in the presence of chain-to-chain competition in a two-period model. Academic/practical relevance: Established findings suggest that SI may alleviate double marginalization and improve the efficiency of a decentralized distribution channel. However, no studies consider the role of SI under chain-to-chain competition. Methodology: We build a two-period model consisting of two competing supply chains, each with an upstream manufacturer and an exclusive retailer. The retailers compete on either price or quantity. We characterize the firms’ strategies under the concept of perfect Bayesian equilibrium. We consider cases where contracts are either observable or unobservable across supply chains. Results: (1) SI still exists under chain-to-chain competition. Retailers may carry more inventory when the competition becomes fiercer, which further intensifies the supply chain competition. (2) Different from the existing findings, SI may backfire and hurt all firms. Interestingly, firms may benefit from a higher inventory holding cost. (3) Under supply chain competition, the prisoner’s dilemma can arise if competition intensity is intermediate; in other words, manufacturers are better off without strategic inventory, and yet they cannot help allowing strategic inventory, which is the unique equilibrium. Managerial implications: Despite its appeal among firms of a single supply chain, the role of SI is altered or even reversed by chain-to-chain competition. Conventional wisdom on SI should be applied with caution.