The Effect of Risk Aversion on Manufacturer Advertising in a Two-Stage Supply Chain

Abstract

Abstract We consider a supply chain system with a risk-neutral manufacturer as the leader and a risk-averse retailer as the follower with uncertain demand. At the beginning of the game, the manufacturer makes efforts on advertising and then the retailer decides its order quantity before demand realization. The retailer's risk aversion is modeled by the Value-at-Risk (VaR) approach with the downside risk constraint. The analysis of equilibrium strategies indicates some characteristics of the game are different from those under risk-neutral assumptions. We find that the manufacturer can effectively prevent the risk-averse retailer from downsizing the order quantity through advertising. In order to explain the difference, we investigate the impacts of risk aversion on the manufacturer's advertising decision and the retailer's ordering decision. We find that the retailer with moderate degree of risk aversion orders a larger volume and receives greater advertising support from the manufacturer. Moreover, the feasible combinations of target profit and downside risk for moderate risk aversion are discussed to derive the relationship of the two parameters. In addition, we make a simple analysis of the situation with two independent retailers who have heterogeneous degrees of risk aversion.