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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2024 Grand Challenge: Business Resilience
Market-Based Solutions to Vital Economic Issues
Jun 4, 2019

The Value of Commitments When Selling to Strategic Consumers: A Supply Chain Perspective


We consider a decentralized supply chain consisting of a retailer and a supplier that serves forward-looking consumers in two periods. In each period, the supplier and the retailer dynamically set the wholesale and retail price to maximize their own profits. The consumers are heterogeneous in their evaluations of the product and are strategic in deciding whether and when to buy the product, choosing the option that maximizes their utility, including waiting for a price markdown. We derive the equilibrium and study the value of price and quantity commitments from both the retailer’s and the supplier’s perspectives. We find that, although a centralized system always benefits from making price and quantity commitments, this is not true for a firm in a decentralized supply chain due to how the other firm responds to these commitments. We show that the retailer suffers from making a price or quantity commitment and that, similarly, the supplier does not benefit from making a price commitment. In these cases, commitments can harm not only the firm itself but also profitability of the other firm in the supply chain, thereby disadvantaging the entire supply chain. This happens because such commitments aggravate double-marginalization inefficiency in the supply chain. Furthermore, we show that eliminating this inefficiency through a coordinating contract (e.g., a two-part tariff or quantity discount) makes commitments beneficial.

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