Production, Manufacturing and Logistics
Strategic commitment versus postponement in a two-tier supply chain

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Abstract

In this paper the trade-off between strategic commitment and operational flexibility is examined as it arises in a supply chain when a supplier offers competing buyers opportunities to make early purchase commitments for a product with a short life cycle. Traditionally, the use of incentives for early purchase commitments for short life-cycle products has been justified on the basis of a supplier's production lead times or capacity constraints. An alternative explanation has been proposed by offering early purchasing opportunities, a supplier can influence the form of competition in the downstream market. Using a single period model, it has been shown that, below a threshold level of demand uncertainty, the supplier can benefit from providing adequate pricing incentives to entice downstream buyers to commit to purchase quantities before demand information is revealed. Moreover, such early purchasing opportunities can benefit the supplier as well as the buyers even in the absence of production lead times or capacity constraints.

Introduction

In many industries that are characterized by short product life cycles, suppliers provide opportunities for downstream buyers to commit to purchase quantities before demand uncertainty has been resolved. For example, manufacturers of fashion apparel, toys, consumer electronics, computer hardware, etc. often encourage retailers to place initial orders long before the products are introduced. These early purchase commitments are typically explained on the basis that they can help a manufacturer to deal with production lead times or capacity constraints that force him to commit to production before demand information is observed. By obtaining early purchase commitments from downstream buyers, the manufacturer can decrease his own risk. For example, see Iyer and Bergen (1997) or Fisher and Raman (1996).

In this paper, we provide an additional justification for why a manufacturer would provide downstream buyers with opportunities to make early purchase commitments. The justification that we propose is based on the role that these opportunities play in shaping competition in the downstream market. Specifically, if a firm in the downstream market can choose between irreversibly committing to an early order and postponing ordering until after better demand information is available, it faces the following trade-off: By postponing its ordering decision, a downstream firm retains operational flexibility to respond to demand information. On the other hand, if it commits to a purchase quantity before its rivals, it can gain the advantages of strategic (Stackelberg) market leadership. We show that by offering appropriate early purchasing opportunities it is possible for a supplier to manipulate this trade-off between flexibility and strategic commitment in the downstream market. Moreover, we show that unless demand uncertainty exceeds a threshold level, it will be in the supplier's interest to make these early purchase opportunities sufficiently attractive to induce early commitment from downstream buyers.

The remainder of the paper is organized as follows: After providing a brief review of the related literature in Section 2, we examine one- and two-part pricing mechanisms that are offered by a monopolistic supplier to downstream duopolistic firms in 3 The model, 4 Franchise policies when there is no natural leader. Finally, we discuss the practical implications and conclusions in Section 5.

Section snippets

Literature review

The real-options literature has examined the benefits of flexibility at many levels of decision making. It is now well understood that this flexibility is of substantial value to a monopolist. For example, McDonald and Siegel (1986) demonstrate the value of flexibility with respect to investment decisions. In more of an operational context several researchers, e.g. Huchzermeier and Cohen (1996), Kogut and Kulatilaka (1994), Dasu and Li (1997), use options pricing paradigms to study the value

The model

Consider a supply chain that consists of a monopolistic supplier and two identical buyers. The product with which this supply chain is concerned has a short life cycle, which can be modeled as a single period. To focus attention on the role that advanced order commitments play in molding the competitive structure in the downstream market, we assume that the supplier is not capacity constrained and that his marginal cost of production is constant and independent of when buyers place their

Franchise policies when there is no natural leader

Our analysis thus far has revealed that it can be advantageous for the supplier to encourage and exploit leadership in the downstream industry when one firm is uniquely capable of making an advanced commitment. Let us now consider what happens when both buyers are capable of making an early commitment. We model this situation as the following game, where stages 1–3 occur prior to the realization of demand information, and stages 4–5 occur after demand information becomes available:

  • Stage 1: The

Discussion

In this paper, we have demonstrated how a supplier can benefit from offering early ordering opportunities to downstream buyers, even in the absence of capacity or lead-time considerations. Specifically, we have examined the way in which a supplier can exploit the fact that a downstream buyer can gain strategic (Stackelberg) leadership advantages from committing to a purchase quantity before his rival(s).

We have shown that when demand uncertainty is sufficiently low, it is in a supplier's best

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