Pricing, service level and lot size decisions of a supply chain with risk-averse retailers: implications to practitioners

Abstract

This article develops a game theoretic model of a supply chain with one supplier and two risk-averse retailers competing in price, service and lot size, where the Economic Order Quantity (EOQ) production-inventory policy is adopted. After studying the existence of EOQ equilibrium, we investigate how to adjust their decisions when the economic environment changes. We find that one retailer will decrease its optimal lot size, retail price and service level when it becomes more risk averse or its service investment efficiency decreases. When the supplier's capacity increases, the retailers will reduce retail price and increase service level, which in turn results in a higher lot size. The effect of the risk sensitivity of one retailer on the rival retailer's decisions depends on the relative service cost efficiency of the retailer. When the absolute risk aversion and service investment efficiency of one retailer increase, the supplier's profitability will increase due to a higher total expected demand. We further give the managerial insights for practitioners, which helps managers to make right decisions in an uncertain environment.

Keywords:

• price–service competition
• inventory
• EOQ
• demand uncertainty
• risk aversion

Acknowledgements

We would like to thank the referees and the guest editors for their many helpful suggestions and insightful comments that have significantly improved the content and presentation of the article. This research was supported in part by: (i) The National Natural Science Foundation of China under Grant 70671055, 70301014, 70571035 and 70731002; (ii) Program for ‘New Century Excellent Talents in University’ (NCET-07-0426) of the Ministry of Education, China; (iii) The Provincial Natural Science Foundation of Jiangsu under Grant BK2008273; and (iv) Scientific Research Foundation of Graduate School of Nanjing University under Grant 2007CW03.