Abundance Versus Scarcity: An Experimental Study of Financially Constrained Newsvendors

Abstract

This study experimentally investigates the ordering behavior of a financially constrained newsvendor-like retailer facing stochastic demand under trade credit. Using controlled laboratory experiments, we examine the ordering behavior of a retailer procuring inventory on trade credit from the supplier under no-bankruptcy risk (NBR) and bankruptcy risk (BR) at low- and high-profit margins. Our experimental observations show deviations from normative optimality, and we find a contrast in the ordering behavior in NBR and BR settings. Compared to the respective normative optimal quantities, in the NBR setting, retailers overorder in the low-profit margin and underorder in the high-profit margin conditions, whereas, in the BR setting, consistent underordering is observed in both the low and high-profit margin conditions. Next, we employ a dynamic panel regression model driven by the demand-chasing heuristic to capture the ordering pattern. Finally, we develop a prospect theoretic model to describe the underordering behavior observed in the BR setting and find that the reference point plays a key role. Our results provide insights into the need to identify the behavior of financially constrained retailers and develop descriptive models for improved decision making.