Inventory Sharing Under Service Competition

Abstract

Problem description: In many markets with demand uncertainties, competing retailers may share inventories for common products that they offer consumers. This paper examines how competitors’ product sharing affects their inventory and service-quality decisions. The existing literature has mainly focused on inventory sharing among independent retailers who do not compete with each other. Our research aims to fill the gap in this literature by investigating the tradeoffs of inventory sharing between retailers who directly compete for customers based on service quality. Methodology/results: We develop a game-theoretical model in which two retailers selling a common product from the same manufacturer compete for customers by offering differentiated services together with the product. Each retailer faces stochastic demand that increases in its service quality and decreases in the competitor’s service quality. When a retailer runs out of stock of the product, it may replenish its inventory directly from the manufacturer and/or request the competitor’s excess inventory if they have an inventory-sharing agreement. We find that inventory sharing may soften or intensify service competition, depending on the transfer price for the shared inventory. Specifically, when retailers agree to share inventory, their service levels decrease in the transfer price if their preseason inventory levels are exogenous, but are nonmonotone in the transfer price if the retailers endogenously choose inventory levels. Moreover, our analysis reveals that the retailers’ equilibrium inventory levels will increase in the transfer price and can be higher or lower than their levels in the case without inventory sharing. We also find that with exogenous inventory, the retailers prefer to share inventory at the highest nonmoot transfer price, whereas with endogenous inventory, the retailers may prefer not to share inventory, even at the optimal transfer price, when the level of competition and the preorder cost are high. Finally, we show that with service competition, inventory sharing cannot achieve full coordination under any transfer price. Managerial implications: When deciding whether to share inventory with competitors, managers should consider not only the benefits of inventory pooling, but also the strategic effect of sharing on the firms’ inventory choices and service levels. Funding: X. Guo has received research support from the Research Grants Council of Hong Kong [RGC Reference No. 15501820]. Supplemental Material: The online appendix is available at https://doi.org/10.1287/msom.2020.0584 .