Cost-benefit associations in consumer inventory problem with uncertain benefit

Abstract

Newsvendor problems always describe a situation in which the vendor needs to predict the demand by a buyer when a constant unit profit is predetermined. However, sometimes, the vendor can effectively affect the demand as well as the unit profit, that is, when he is also the buyer simultaneously. Should he purchase more or less in advance when both the demand and unit benefit are uncertain? In this paper, we study how the vendor/buyer (consumer hereafter) would make this inventory decision when the unit profit is uncertain. We first analyze the evaluating process of consumers by conducting a mathematical model to contribute to the understanding of how the cost-benefit association affects consumer inventory decisions. Consumers would experience an immediate pain of payment (cost) at the order time, which is associated to thoughts of the uncertain pleasure (benefit) such payment may provide at the consumption time. The result shows the cost-benefit association might encourage consumers to either over- or underestimate the pain of paying and thereby take economically sub-optimal decisions. Based on this finding, we conduct three laboratory experiments to analyze the parameters in our model. Contrary to the existing literature, we find that the demand uncertainty may enhance consumer inventory decisions. Specifically, when the benefit uncertainty is really high, a strong cost-to-benefit link caused by the small probability of a great outcome would prevail against a weak benefit-to-cost link, leading to more deviation from the theoretical optimal quantity. Interestingly, we also show that changes to the benefits can lead to more deviation in order quantity, that is, a direct effect of benefit and an indirect impact on demand would jointly make changes to the benefits more effective than changes to the cost. Our finding has important implications on how firms should set prices and inventories of seasonal goods and how much money should invest in promoting pre-purchase behaviors (e.g., store cards).