Leveraging Quality Information in Stock-Outs

We study the informational role stock-outs may play when consumers have heterogeneous information about the quality of a firm’s product. Typically, in a newsvendor world, matching uncertain demand with inventory leads inevitably to stock-outs. When, in addition, consumers are heterogeneously informed about the quality of the firm’s product, stock-outs caused early in the season by savvy consumers may be an indication of high quality for the less savvy consumers later in the season. The firm can leverage their increased willingness to pay after a stock-out via increased prices. As a consequence, in the presence of quality uncertainty, a firm may want to manipulate inventory early in the season to create stock-outs in order to take advantage of increased willingness to pay later in the season. In our model, stock-outs can thus be caused either by the firm’s inventory manipulations, or by market uncertainty. We find conditions under which stock-outs are an indication of high quality. Our model provides an explanation for frequently reported stock-outs of consumer electronic products or toys, whose potential markets are characterized by significant market uncertainty, but, also, whose quality may not be fully known by all consumers in the market. Compared to the case in which consumers do not observe stock-out information, we find that the firm rationally underinvests in inventory, which causes backorder costs early in the season that are leveraged later in the season via increased sales revenues. Interestingly, we find that the difference in price after a stock-out versus after no stock-out, and the equilibrium stock-out probability, can either increase or decrease with more-savvy early-season consumers.