Commitment Strategies and Inventory Decisions Under Supply Disruption Risk

Problem definition: Manufacturers' production capacity may be disrupted as a result of a pandemic outbreak, trade frictions, military conflicts, etc. This paper develops a two-period supply chain model with disruption risk in the second period to investigate firms' inventory decisions and the manufacturer's optimal price or inventory commitment strategies.Academic/practical relevance: Our paper contributes to the inventory management literature and the commitment literature by identifying how supply disruption risk affects firms' inventory decisions and optimal commitment strategy.Methodology: We consider a manufacturer's three strategies under supply disruption risk: price commitment (PC), inventory commitment (IC), and no commitment (NC). Under each strategy, we optimize the manufacturer's inventory and wholesale price decisions and the retailer's inventory and order quantity decisions. Comparing the three strategies leads to the manufacturer's optimal strategy.Results: Supply disruption risk drives distinctive results compared to the case without supply risk. First, the retailer may have two opposite motives for inventory holding: inventory-building motive and inventory-shifting motive (i.e., shifting inventory to the manufacturer), where the latter motive cannot exist without supply risk. Strategy PC suppresses both motives and $IC$ suppresses only the inventory-shifting motive. Second, under strategy PC, the manufacturer charges prices so that the retailer never holds inventory. Under strategies NC or IC, the manufacturer's optimal inventory is zero without supply risk, but may be positive with supply risk. The manufacturer's inventory can decrease as supply risk increases when holding cost is sufficiently low. In terms of the choice among the three strategies, the manufacturer (weakly) prefers IC to the other two strategies. However, only for low holding cost and high disruption risk, IC strictly outperforms both of the other two strategies. PC can perform either better or worse than NC. Managerial implications: For high supply risk and low holding cost, the manufacturer should consider investing in inventory transparency to implement strategy IC. In situations where it is unable to implement IC, PC should be adopted under circumstances when it outperforms NC. This is in sharp contrast with the literature without supply risk that shows PC never outperforms NC