The reference effect in newsvendor model with strategic customers

Abstract

PurposeThe purpose of this paper is to discuss the role of reference effect on newsvendor’s decision behavior in a market with strategic customers and work out the newsvendor’s optimal pricing policy and ordering quantity.Design/methodology/approachThis study utilizes the prospect theory and strategic customer framework to analyze the decision-making behavior on the newsvendor’s optimal pricing policy and ordering quantity. The paper further presents an extension of newsvendor model and provides the model’s properties. The paper finally analyzes the results with various parameters on the model and reports on the insights generated by the model.FindingsThe paper indicates that the ordering quantity is not altered with the changing proportion of strategic customers and myopic customers, but the ordering quantity and the pricing strategy are influenced in terms of newsvendor’s reference effect, loss aversion, product cost, and salvage price.Practical implicationsThe research findings have important implications for decision makers. Previous researches have studied the incomplete rationality newsvendor’s decision-making behavior mainly by analyzing the vendor’s risk preferences or loss aversion, but the effect of reference point also plays an important role in analyzing the decision-maker’s behavior. The paper provides the optimal pricing policy and ordering quantity with the reference effect considering the strategic customers behavior. This model is also a valid complementarity to behavioral operations management research area.Originality/valueThe paper examines the role of reference effect in newsvendor problem with the strategic customers and analyzes the impact of parameters such as loss aversion on the newsvendor’s decision behavior.