The value of information sharing in a multi-product supply chain with product substitution

Abstract

The extant literature on the value of information sharing within a supply chain has investigated only the case in which the supply chain manufactures and distributes a single product to customers. In this paper, the case in which a supply chain distributes multiple products is considered. These products may also be substitutable in the sense that a consumer may be willing to buy an alternate product when the customer's preferred product is out of stock. It is shown that substitutability among products generally reduces the value of information sharing and that the reduction is increasing in the degree of substitution. This result occurs because of two reasons. First, the demand-pooling effect of substitution reduces demand variance, and the reduction in demand variance because of substitution is higher when the degree of substitution is higher. Second, substitution increases the base level profit when information is not shared. The reduction in the value of information sharing because of substitutability is higher when the number of substitutable products is lower, the demands of products are less correlated or when the number of products whose information is shared is higher. When information about the demands of only a subset of products is shared, the value of information sharing under substitution is higher than that under no substitution under certain conditions. However, in these conditions the inventory holding and shortage costs are significantly low, relative to the profit margin, causing the value of information sharing to be low. The key implication of these findings is that if substitution effects are ignored, then there is a risk of overestimating the value of information sharing. The overestimate can be very significant when the degree of substitution is higher, the number of substitutable products is smaller, demands of these products are less correlated and more independent or when the number of products whose information is shared is higher.

Keywords:

• Value of information sharing
• supply chain
• multiple products
• substitution

Notes

¹ See Lee et al. (2000) for the impact of manufacturer and retailer lead times on the benefits of information sharing. Our results will not change qualitatively for any constant lead time.

²This substitution model is known in the literature as the “random substitution” model (Mahajan and Ryzin, 2001).

³If the retailer's order is not fully satisfied, then the retailer should take expectation with respect to the quantity s/he will receive from the manufacturer while determining the order-up-to levels.

⁴The expected shortage can be expressed as an integral whose value can only be numerically computed. Further, Lee et al. (2000) showed that approximating the total cost by only the inventory holding cost does not result in a significant error.