Push, Pull, or Both? A Behavioral Study of How the Allocation of Inventory Risk Affects Channel Efficiency

In this paper we experimentally investigate how the allocation of inventory risk in a two-stage supply chain affects channel efficiency and profit distribution. We first evaluate two common wholesale price contracts that differ in which party incurs the risk associated with unsold inventory: a push contract in which the retailer incurs the risk and a pull contract in which the supplier incurs the risk. Our experimental results show that a pull contract achieves higher channel efficiency than that of a push contract, and that behavior systematically deviates from the standard theory in three ways: (1) stocking quantities are set too low, (2) wholesale prices are more favorable to the party stocking the inventory, and (3) some contracts are erroneously accepted or rejected. To account for these systematic regularities, we extend the existing theory and structurally estimate a number of behavioral models. The estimates suggest that a combination of loss aversion with errors organizes our data remarkably well. We apply our behavioral model to the advance purchase discount (APD) contract, which combines features of push and pull by allowing both parties to share the inventory risk, in a separate experiment as an out-of-sample test, and we find that it accurately predicts channel efficiency and qualitatively matches decisions. Two practical implications of our work are that (1) the push contract performs close to standard theoretical benchmarks, which implies that it is robust to behavioral biases, and (2) the APD contract weakly Pareto dominates the push contract; retailers are better off and suppliers are no worse off under the APD contract.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2014.1940 . This paper was accepted by Serguei Netessine, operations management.