The Implications of Visibility on the Use of Strategic Inventory in a Supply Chain

Abstract

It is now widely accepted that a retailer’s use of strategic inventory can mitigate double marginalization and improve the coordination of a supply chain, potentially benefiting both the downstream retailer and an upstream manufacturer. However, this conclusion has typically been based on the assumption that the manufacturer can observe the retailer’s level of inventory before making wholesale pricing decisions. In reality, there are many situations in which neither the retailer’s sales nor inventory are observable to the manufacturer, effectively concealing the action taken by the retailer. We investigate the implications of such a lack of observability on the use of strategic inventory in a supply chain consisting of a single retailer and a single manufacturer. We find that the manufacturer’s inability to observe inventory has significant implications for the amount of inventory and the range of holding cost for which it is held in equilibrium. In addition, we find that, in the absence of any form of uncertainty, which the manufacturer could benefit from responding to, he may prefer not to observe the retailer’s inventory. On the other hand, the retailer’s willingness to make her inventory visible depends on the holding cost. The electronic companion is available at https://doi.org/10.1287/mnsc.2018.3033 . This paper was accepted by Gad Allon, operations management.