The bright side of the planning fallacy in distribution channels

Abstract

The planning fallacy describes the tendency of people to underestimate the costs and to overestimate the benefits of investments. It is typically associated with cost overruns and decreased performance. In this paper, we demonstrate that in a simple distribution channel with an upstream manufacturer and a downstream retailer that both make demand-enhancing investments, there is a bright side of the planning fallacy: managerial optimism bias that results in underestimated investment costs can in fact lead to a win-win outcome which makes the manufacturer, the retailer, and consumers better off than without bias. Moreover, the total profit of the decentralized distribution channel can be even higher than the centralized channel’s profit. We find that our results are robust to changes in the sequencing of decisions and continue to hold under generalized Nash bargaining over the wholesale price as well as under upstream or downstream competition or consumer demand uncertainty.