Tuesday, November 26, 2013

Willingness to Pay for Shifting Inventory Risk – The Role of Contractual Form

Access the publisher's website
Production and Operations Management Journal 23, 2 (2014) 239-252

In order to reduce their inventory risk, firms can attempt to contract with their sup-pliers for shorter supply lead times, with their buyers for longer demand lead times,or both. We designed a controlled laboratory experiment to study contracts that shift a focal firm's inventory risk to its supply chain partners, and address two questions.First, is it more effective if the cost of shifting inventory risk is framed as a fixed fee or in per-unit cost terms? We find that, generally, our participants are willing to pay more to avoid supply-demand mismatches than the expected costs from such mis-matches. This tendency to overpay is mitigated under fixed fee schemes. Second, does it matter whether the option to reduce inventory risk is the outcome of either increased responsiveness from the upstream supplier, or advanced demand information from the downstream buyer? Our results suggest that this difference, when only a matter of framing, has no significant effect on willingness-to-pay.