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Role of Risk Aversion in Price Postponement Under Supply Random Yield

Author

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  • Panos Kouvelis

    (Olin Business School, Washington University in St. Louis, St. Louis, Missouri 63130)

  • Guang Xiao

    (PolyU Faculty of Business, The Hong Kong Polytechnic University, Hung Hom 999077, Hong Kong, China)

  • Nan Yang

    (Miami Herbert Business School, University of Miami, Coral Gables, Florida 33146)

Abstract

Price postponement is an effective mechanism to hedge against the adverse effect of supply random yield. However, its effectiveness and the resulting production decisions have not been studied for risk-averse firms. In this paper, we investigate the impact of price postponement and risk aversion under supply yield risk. Specifically, we study a risk-averse monopoly firm’s production and pricing decisions under supply random yield with two distinct pricing schemes: (1) ex ante pricing in which the firm simultaneously makes the sales price and sourcing decisions before production takes place and (2) responsive pricing in which the pricing decision is postponed until after the production yield realization. We adopt conditional value at risk (CVaR) as the risk-aversion measurement and investigate the impact of the firm’s risk-aversion level on its optimal decisions and the corresponding profit. Among other results, we show that, for each pricing scheme, there exists a unique risk-aversion threshold under which the firm chooses not to produce. Interestingly, price postponement has no impact on the risk-aversion threshold as the cutoff values under both pricing schemes are the same. We further show that the value of CVaR improvement from responsive pricing may not be monotonic in the firm’s risk-aversion level. Consequently, our results indicate that, although price postponement induces operational flexibility by better matching demand with available supply, whether the firm should adopt responsive pricing needs to be carefully evaluated as the benefit may not justify the potential fixed cost associated with price postponement, especially for a highly risk-averse firm. In addition, we show that responsive pricing, even with its ex post revenue-maximization behavior, benefits the end-market consumers in equilibrium. Finally, we conduct extensive numerical studies to check and confirm the robustness of our results.

Suggested Citation

  • Panos Kouvelis & Guang Xiao & Nan Yang, 2021. "Role of Risk Aversion in Price Postponement Under Supply Random Yield," Management Science, INFORMS, vol. 67(8), pages 4826-4844, August.
  • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:8:p:4826-4844
    DOI: 10.1287/mnsc.2020.3755
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    References listed on IDEAS

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