The interplay between strategic inventories and cost misreporting in supply chains

Abstract

For retailers, carrying inventories may force suppliers to lower wholesale prices in their future transactions. Previous literature on strategic inventories has assumed that the unit production cost of the supplier is negligible. In practice, the production cost is the supplier’s private information. In this research, we study the impact of supplier’s cost misreporting behavior on supply chain decisions in a two-period strategic inventory basic model consisting of a retailer and a supplier. We find that the retailer’s retention of strategic inventories can incentivize the supplier to misreport costs. As the retailer carries inventories, the supplier can misreport a higher cost, thus increasing the wholesale price and supplier’s profit margins. Moreover, we find that misreporting behavior hurts the retailer and exacerbates the double marginalization effect, leading to inefficiency in the supply chain. The supplier’s profit is further improved when the supplier can misreport the different costs in each period. When we consider competition from downstream retailers, only if both two retailers do not hold strategic inventories, can they prevent the supplier from misreporting. The retailer’s detection measures are needed to ensure the coordination role of strategic inventory.