Push, Pull, or Both?: A Behavioral Study of Inventory Risk on Channel Efficiency

Abstract

In this paper we experimentally investigate how the allocation of inventory risk in a two-stage supply chain affects channel efficiency. We first evaluate two common wholesale price contracts that differ in which party incurs the risk associated with unsold inventory; a push contract in which the retailer incurs the risk, and a pull contract in which the supplier incurs the risk. Our experimental results show that a pull contract achieves higher channel efficiency than that of a push contract, and that behavior systematically deviates from the standard theory. Therefore, we extend the existing theory to incorporate a number of behavioral regularities and structurally estimate its parameters. The estimates suggest that a combination of errors with loss aversion organizes our data remarkably well. Following this we explore a third contract, the advanced purchase discount (APD) contract, which combines certain features of push and pull by allowing both parties to share the inventory risk. We apply our behavioral model to the APD contract in a separate experiment as an out-of-sample test and find that it accurately predicts channel efficiency and qualitatively matches decisions. Lastly, from a managerial perspective, we observe that the APD contract weakly Pareto dominates the push contract; retailers are better off and suppliers are no worse off under the APD contract.