Strategic Inventory and Supplier Encroachment

Problem definition: In a two-period model of a dyadic supply chain, we study the interaction between the use of strategic inventory withholding by the buyer and the use of a direct selling channel (encroachment) by the supplier in the second period. Academic/practical relevance: While the extant OM literature has individually examined the two strategies, the system-wide combined effect of these strategies has not been studied. Methodology: We fill the gap by building and analyzing two decentralized models of vertical competition. The main model focuses on sequential quantity decisions where the buyer decides on its order quantity and sets its selling quantity, with a first-mover advantage, before the supplier decides on its direct selling quantity. In an extension, we also consider an alternative timing structure of simultaneous quantity competition. Results: For the sequential model, we find that for any finite holding cost, the buyer may withhold strategic inventory in certain cases. This makes the supplier less aggressive in using its direct selling strategy compared to the case when strategic inventory is not an option. Moreover, there exist situations where both the supplier and the buyer make higher profits from the combined use of their respective strategies at the same time. For the simultaneous model, the buyer can achieve higher profit than in the sequential model in certain scenarios. However, the supplier’s profit may drop below the benchmark case (when neither strategic inventory nor direct selling is present), which is not seen in the sequential model. As such, the buyer can benefit from losing its first-mover advantage, whereas the supplier may be worse off. Managerial implications: Our study provides useful managerial insights into the strategic (joint) moves of the players in a supply chain. We show that both the supplier and the buyer can benefit from vertical competition. Moreover, the first-mover advantage may not always increase profits for the players.