Strategic Communication for Capacity Alignment with Pricing in a Supply Chain

Abstract

We study a supply chain comprised of a retailer who sources a product from a manufacturer. The retailer has superior forecast information about market demand, and the manufacturer builds up capacity and sets the wholesale price prior to demand realization. We explore forecast information sharing between the retailer and the manufacturer by means of cheap talk. We show that meaningful forecast information can be shared truthfully only before the manufacturer sets both capacity and the wholesale price. By sharing demand forecast with the manufacturer, the retailer faces the tradeoffs between inflating the forecast in order to convince the manufacturer to increase capacity and deflating the forecast to persuade the manufacturer to offer a lower wholesale price. When the value of forecast information sharing is high, the tradeoffs are balanced, and incentives are aligned, leading to truthful information sharing. Moreover, we find that larger demand uncertainty can promote credible information sharing, and, surprisingly, can benefit both firms. Finally, we demonstrate that under general distributions, in equilibrium, firms share forecasts as a form of range/interval, which has been also implemented in practice.