Strategic Communication for Capacity Alignment with Pricing in a Supply Chain

Abstract

We study a supply chain comprised of a retailer who sources a product from a manufacturer. The retailer has superior information about the market demand, and the manufacturer must build the capacity and set the wholesale price prior to observing demand realization. We explore the level of information the retailer can share with the manufacturer by means of cheap talk. We first analyze a case in which the demand distribution is discrete and show that under mild conditions, the supply chain participants can exchange information truthfully. This result stands in sharp contrast with the existing literature which shows that in a static model without behavioral concerns, such as trust, the retailer tends to manipulate the demand forecasting information; hence, information cannot be shared truthfully under a wholesale price contract. The underlying reason for this result is the fact that the manufacturer undertakes multiple actions based on the information received from the retailer; for example, she makes the operational decision of setting the capacity level as well as the marketing decision of setting the wholesale price. When sharing information, the retailer must consider the trade-off between his incentive to inflate the shared information in order to encourage the manufacturer to increase the capacity level, and to deflate the forecast information, which results in a reduced wholesale price. We demonstrate that these countervailing incentives can balance each other and lead to a truthful information exchange. We also show that information sharing can hurt the supply chain. For more general continuous demand distributions, we first find that full information sharing is not possible. We then demonstrate that by sharing sub-interval information, the supply chain partners can still reach some level of partial information exchange. Finally, we illustrate via a numerical study that as the manufacturer's capacity build-up cost increases, her profit can increase as well, since it encourages the retailer to share more information with the manufacturer.

Public Forecast Information Sharing in a Market with Competing Supply Chains

“…Ozer et al (2011) study the e¤ect of trust and trustworthiness on the ability to share information by means of cheap talk. Finally, Chu et al (2015) demonstrate that when a manufacturer takes multiple actions (setting capacity and a wholesale price) based on the received information from the retailer, truthful information sharing can be achieved in equilibrium. This paper adds to this line of work by o¤ering a new mechanism for sharing information between a retailer and his manufacturer via informal talk under a simple wholesale price contract; in our case, the retailer, endowed with superior information, is able to achieve truthful information sharing with his manufacturer by sharing the information with the competing supply chain.…”

“…Similar assumptions are commonly used in models with asymmetric information. See, for example,Cachon and Lariviere (2001),Ha and Tong (2008),Anand and Goyal (2009) andChu et al (2015). Furthermore, in Section 8, we study a more general demand distribution.5 The assumption of identical production cost can be relaxed without qualitatively altering the results of the paper.…”

“…We present the results when this assumption is relaxed in Section 8.2.6 The use of exogenous wholesale price is common in models with an endogenous capacity level and asymmetric information.Ozer and Wei (2006),Anand and Goyal (2009) and Ozer et al (2011) are a few examples that make a similar assumption and use an exogenous wholesale price. In other papers that adopt the assumption that the wholesale price is endogenously determined, the capacity is usually determined exogenously(Ha and Tong 2008) Chu et al (2015). provide an analysis of a supply chain in which both the capacity level and the wholesale price are determined endogenously.…”

“…0 A similar parameter was used byAnand and Goyal (2009) andChu et al (2015) as a proxy for the demand uncertainty.…”

Inventory Decisions and Signals of Demand Uncertainty to Investors

“…Different from voluntary information sharing or signaling, several recent studies have investigated whether supply chain parties can truthfully share information through cheap talk. Chu et al (2013) and Shamir and Shin (2013) find that credible information dissemination with cheap talk is possible when there are conflicting tradeoffs, e.g., announcing a large demand forecast may induce large capacity investment but may also trigger price increase or downstream competition. Our study differs from this literature as we focus on the interactions between firms and their investors.…”