Selling to strategic and loss-averse consumers: Stocking, procurement, and product design policies

Chang Hwan Lee, Tsan Ming Choi, T. C.E. Cheng

Research output: Journal article publicationJournal articleAcademic researchpeer-review

30 Citations (Scopus)

Abstract

Naval Research Logistics 62: 435-453, 2015 Motivated by the presence of loss-averse decision making behavior in practice, this article considers a supply chain consisting of a firm and strategic consumers who possess an S-shaped loss-averse utility function. In the model, consumers decide the purchase timing and the firm chooses the inventory level. We find that the loss-averse consumers' strategic purchasing behavior is determined by their perceived gain and loss from strategic purchase delay, and the given rationing risk. Thus, the firm that is cognizant of this property tailors its inventory stocking policy based on the consumers' loss-averse behavior such as their perceived values of gain and loss, and their sensitivity to them. We also demonstrate that the firm's equilibrium inventory stocking policy reflects both the economic logic of the traditional newsvendor inventory model, and the loss-averse behavior of consumers. The equilibrium order quantity is significantly different from those derived from models that assume that the consumers are risk neutral and homogeneous in their valuations. We show that the firm that ignores strategic consumer's loss-aversion behavior tends to keep an unnecessarily high inventory level that leads to excessive leftovers. Our numerical experiments further reveal that in some extreme cases the firm that ignores strategic consumer's loss-aversion behavior generates almost 92% more leftovers than the firm that possesses consumers' loss-aversion information and takes it into account when making managerial decisions. To mitigate the consumer's forward-looking behavior, we propose the adoption of the practice of agile supply chain management, which possesses the following attributes: (i) procuring inventory after observing real-time demand information, (ii) enhanced design (which maintains the current production mix but improves the product performance to a higher level), and (iii) customized design (which maintains the current performance level but increases the variety of the current production line to meet consumers' specific demands). We show that such a practice can induce the consumer to make early purchases by increasing their rationing risk, increasing the product value, or diversifying the product line.
Original languageEnglish
Pages (from-to)435-453
Number of pages19
JournalNaval Research Logistics
Volume62
Issue number6
DOIs
Publication statusPublished - 1 Sep 2015

Keywords

  • agile supply chain
  • bounded rationality
  • marketing-operations interface
  • S-shaped loss-averse utility
  • strategic and loss-averse consumer behavior

ASJC Scopus subject areas

  • Modelling and Simulation
  • Ocean Engineering
  • Management Science and Operations Research

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