Willingness to Pay for Shifting Inventory Risk: The Role of Contractual Form

• Published in: Production and operations management Vol. 23; no. 2; pp. 239 - 252
• Main Authors: Kremer, Mirko, Van Wassenhove, Luk N.
• Format: Journal Article
• Language: English
• Published: Los Angeles, CA Blackwell Publishing Ltd 01.02.2014; SAGE Publications; Blackwell Publishers Inc
• Subjects: fixed fee and per-unit contracts; Inventory management; newsvendor decisions; Risk management; Studies; Suppliers; Supply chain management; value of demand information; Willingness to pay; value of demand information; fixed fee and per‐unit contracts; newsvendor decisions
• ISSN: 1059-1478; 1937-5956
• DOI: 10.1111/poms.12179

In order to reduce their inventory risk, firms can attempt to contract with their suppliers for shorter supply lead‐times, with their buyers for longer demand lead‐times, or both. We designed a controlled laboratory experiment to study contracts that shift a focal firm's inventory risk to its supply chain partners and address two questions. First, is it more effective if the cost of shifting inventory risk is framed as a fixed fee or in per‐unit cost terms? We find that, generally, our participants are willing to pay more to avoid supply–demand mismatches than the expected costs from such mismatches. This tendency to overpay is mitigated under fixed fee schemes. Second, does it matter whether the option to reduce inventory risk is the outcome of either increased responsiveness from the upstream supplier or advanced demand information from the downstream buyer? Our results suggest that this difference, when only a matter of framing, has no significant effect on willingness‐to‐pay.