Who carries strategic inventory? Manufacturer or retailer

Abstract It is widely accepted that the retailer's use of strategic inventory can mitigate double marginalization and improve supply chain coordination. However, the recent literature of channel coordination only considers the effects of the retailer's strategic inventory, leaving the manufacturer's incentive to hold strategic inventory mostly unexplored. In reality, there are situations where the manufacturer's inventory can be observed or inferred by the retailer and hence affects the vertical interaction. In our two‐period dynamic model, we show that the manufacturer in equilibrium may carry a positive amount of inventory, which yields a significant impact on the equilibrium decisions and the supply chain players' profits. Specifically, we find that the manufacturer's use of strategic inventory commits a lower propensity to resume production in the second period, thereby encouraging the retailer to carry more strategic inventory at a higher wholesale price in the first period. The manufacturer's use of strategic inventory always hurts the retailer's profit but may enhance channel profit, consumer surplus, and social welfare. Moreover, we show that the manufacturer can earn an even higher profit by directly committing to no replenishment in the second period, observed in industries with longer production lead time and higher production setup costs.