A two-period game-theoretic model for the equilibrium decisions in the presence of strategic inventory in supply chain management

Investment efforts by the upstream manufacturer and the downstream retailer to stimulate sales are prevalent in different industries. Likewise, the downstream retailers could hold inventory strategically as a bargaining chip to induce the upstream manufacturer to reduce future wholesale prices in the supply chain. Anticipating such strategic behavior of the retailer, the manufacturer responds by increasing the early period wholesale price, which might weaken the impact of the investment efforts due to a rising price. Our central research questions are: Under what conditions do the retailer and the manufacturer benefit from investment effort, and how does strategic inventory affect the efficiency of the supply chain? Therefore, we develop a two-period game-theoretic model and characterize the equilibrium decisions and profits for inventory holding and investment effort patterns. Results demonstrate that the retailer’s inventory holding decision can significantly reduce the impact of the manufacturer’s investment effort, and the manufacturer even receives lower profits compared to the scenario where strategic inventory is not withheld. The finding contrasts with the existing research, which suggests that the manufacturer always receives higher profit if the retailer holds inventory in a supply chain. Further, we investigate the incremental or detrimental effect of base demand on the second period. We find that the retailer’s strategic inventory can hurt both members of the supply chain even if there is a sizable increment in market size in the second period, and both members could be worse off.