Inventory Sharing and Demand-Side Underweighting

Problem definition : Transshipment/inventory sharing has been used in practice because of its risk-pooling potential. However, human decision makers play a critical role in making inventory decisions in an inventory sharing system, which may affect its benefits. We investigate whether the opportunity to transship inventory influences decision makers’ inventory decisions and whether, as a result, the intended risk-pooling benefits materialize. Academic/practical relevance : Previous research in transshipment, which is focused on finding optimal stocking and sharing decisions, assumes rational decision making without any systematic bias. As one of the first to study inventory sharing from a behavioral perspective, we demonstrate a persistent stocking-decision bias relevant for inventory sharing systems. Methodology : We develop a behavioral model of a multilocation inventory system with transshipments. Using four behavioral studies, we identify, test, estimate, and mitigate a demand-side underweighting bias: although inventory sharing brings both a supply-side benefit and a demand-side benefit, players underestimate the latter. We show analytically that such bias leads to underordering. We also explore whether reframing the inventory sharing decision reduces this bias. Results : Our results show that subjects persistently reduce their order quantities when transshipments are allowed. This underordering, which persists even when a decision-support system suggests optimal quantities, causes insufficient inventory in the system, in turn reducing the risk-pooling benefits of inventory sharing. Underordering is evidently caused by an underweighting bias; although players correctly estimate the supply-side potential from transshipment, they only estimate 20% of the demand-side potential. Managerial implications : Although inventory sharing can profitably reduce inventory, too much underordering undermines its intended risk-pooling benefits. The demand-side benefits of transshipment need to be emphasized when implementing inventory sharing systems.