When Customers Anticipate Liquidation Sales: Managing Operations under Financial Distress

Abstract

The presence of strategic customers may force an already financially distressed firm into a death spiral: sensing the firm’s financial difficulty, customers may wait strategically for deep discounts in liquidation sales. In turn, such waiting lowers the firm’s profitability and increases the firm’s bankruptcy risk. Using a two-period model to capture these dynamics, this paper identifies customers' strategic waiting behavior as a source of a firm’s cost of financial distress. We also find that customers' anticipation of bankruptcy can be self-fulfilling: when customers anticipate a high bankruptcy probability, they prefer to delay their purchases, making the firm more likely to go bankrupt than when customers anticipate a low probability of bankruptcy. Such behavior has important operational and financial implications. First, the firm acts more conservatively when facing either more severe financial distress or a large share of strategic customers. As its financial situation deteriorates, the firm lowers ...