Contingency Inventory Reservation for Low-Probability High-Impact Events

Abstract

This article investigates reservation contracts for contingency inventory management between two buyers and a single supplier under a game theoretic framework. Two channel structures are considered in this context. In the first setting, the buyers simultaneously move to offer reservation fees to the supplier, who in turn, decides on the inventory amount she wants to carry for each buyer. In the second setting, the supplier moves first and offers nonrefundable-deductible reservation fees for the buyers, who respond with their respective reservation quantities. By reserving through a shared supplier, the buyers enable a contingency inventory pool which alleviates overage risk for the supplier and enables availability of products after low-probability high-impact events. Conditions for successful implementation of contingency reservation contracts are investigated. The results obtained for both channel structures were contrasted. It is shown that in a market where the buyers have more negotiation power, reservation contracts are more likely to achieve inventory buildup under relatively lower event probabilities.