Strategic Inventories Under Supply Chain Competition

Abstract

Established findings suggest that strategic inventory may alleviate double marginalization and improve the efficiency of a decentralized distribution channel. In this paper, we examine the effect of strategic inventory in the presence of chain-to-chain competition. We show that as the competition between two supply chains becomes fiercer, retailers will carry more inventory, which intensifies the supply chain competition. Consequently, this competition intensification effect can overshadow the effect of double marginalization alleviation. We document the possibility that under supply chain competition, manufacturers can strictly prefer the elimination of inventories to strategic inventories. Moreover, when manufacturers choose between strategic inventory operations (e.g., dynamic contracts) and no inventory operations (e.g., commitment contracts), the prisoner’s dilemma can arise if the competition intensity is intermediate; in other words, the manufacturers are better off with no inventory operations, and yet they cannot help carrying strategic inventory, which is the unique equilibrium.