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Inventory Dynamics and Supply Chain Coordination

Sauder School of Business, University of British Columbia, Vancouver, British Columbia V6T 1Z2, Canada
Sauder School of Business, University of British Columbia, Vancouver, British Columbia V6T 1Z2, Canada
harish.krishnan{at}sauder.ubc.ca
ralph.winter{at}sauder.ubc.ca

This paper extends the theory of supply chain incentive contracts from the static newsvendor framework of the existing literature to the simplest dynamic setting. A manufacturer distributes a product through retailers who compete on both price and fill rates. We show that inventory durability is the key factor in determining the underlying nature of incentive distortions and their contractual resolutions. When the product is highly perishable, retailers are biased toward excessive price competition and inadequate inventories. Vertical price floors or inventory buybacks (subsidies for unsold inventory) can coordinate incentives in both pricing and inventory decisions. When the product is less perishable, the distortion is reversed and vertical price ceilings or inventory penalties can coordinate incentives.

Key Words: supply chain coordination; inventory dynamics; price and inventory competition; contracts
History: Received: June 27, 2008; accepted: September 18, 2009.