This Article Full Text (PDF) References Alert me when this article is cited Alert me if a correction is posted Services Email this article to a friend Similar articles in this journal Alert me to new issues of the journal Download to citation manager Citing Articles Citing Articles via HighWire Citing Articles via Google Scholar Google Scholar Articles by Netessine, S. Articles by Zhang, F. Search for Related Content

Positive vs. Negative Externalities in Inventory Management: Implications for Supply Chain Design

The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104-6366
Graduate School of Management, University of California, Irvine, California 92697-3125
netessine{at}wharton.upenn.edu
fzhang{at}uci.edu

In this paper we analyze the impact of supply-side externalities existing among downstream retailers on supply chain performance. Namely, multiple retail firms face stochastic demand, purchase the product from the upstream wholesaler, and make stocking decisions that affect all other retailers in the same echelon. Two sources of inefficiencies exist in such a supply chain: One is double marginalization and the other is externalities among retailers. Whereas double marginalization always leads to inventory understocking at the retail echelon, we find that the implications of externalities are more complex, because different externalities can improve or deteriorate supply chain performance, relative to the situation without externalities.

We show that the effect of externalities depends critically on whether the stocking decisions of retailers exhibit positive (complementarity) or negative (substitutability) externalities, and whether retailers are managed centrally or competitively. Under complementarity, competing retailers tend to understock the product (compared with the centralized inventory management at the retail level), thus aggravating the double-marginalization effect. This is the opposite of what happens under substitutability, where competing retailers tend to overstock the product, thus compensating for the double-marginalization effect. Hence, we conclude that supply chain coordination between retailers and the wholesaler is most important when there is downstream competition that exhibits complementarity. From the wholesaler's point of view, competition among retailers is preferable over centralization of retailers when externalities are negative, and vice versa when externalities are positive. Moreover, with competition on complements, both retailers and the wholesaler have incentives to coordinate the supply chain.

Key Words: supply chain; game theory; competition; Nash equilibrium; complementarity; supermodularity
History: Received: January 21, 2003; accepted: November 22, 2004.

This article has been cited by other articles:

				L. Dong, C. Narasimhan, and K. Zhu Product Line Pricing in a Supply Chain Management Science, October 1, 2009; 55(10): 1704 - 1717. [Abstract] [PDF]

				X. Su and F. Zhang Strategic Customer Behavior, Commitment, and Supply Chain Performance Management Science, October 1, 2008; 54(10): 1759 - 1773. [Abstract] [PDF]

				D. Granot and S. Yin Competition and Cooperation in Decentralized Push and Pull Assembly Systems Management Science, April 1, 2008; 54(4): 733 - 747. [Abstract] [PDF]

				F. Bernstein, G. A. DeCroix, and Y. Wang Incentives and Commonality in a Decentralized Multiproduct Assembly System Operations Research, July 1, 2007; 55(4): 630 - 646. [Abstract] [PDF]