Strategic inventory and supplier development investment under downstream competition

We investigate the interaction between the buyers’ strategic inventory (SI) option and supplier development investment in a two-period supply chain model consisting of a common supplier and two competing buyers. Prior studies suggest that SI held by the buyer induces the supplier to lower the second-period wholesale price, thereby alleviating double marginalization. Our study adds to this literature by introducing supplier development undertaken by the buyers to reduce the supplier’s second-period production cost. Two scenarios are considered in which supplier development is present: specific investment, where spillover from supplier development cannot occur, and generic investment, where supplier development yields spillover to a rival buyer. We demonstrate that without investment, SI can benefit both the supplier and the buyers when the inventory holding cost is low. However, in the presence of supplier development investment, having the SI option discourages the buyers from investing, and thus may hurt all firms, even if the inventory holding cost is absent. By examining the impact of specific investment, we show that, without the SI option, specific investment always hurts the buyers compared to no investment. In contrast, with the SI option, specific investment can benefit the buyers by inducing them to abandon inventories. We also study the impact of generic investment and find that, without the SI option, the buyers always benefit from generic investment. Interestingly, with the SI option, generic investment can lead to higher wholesale prices in both periods for investing buyers than those under no investment. This consequently hurts the buyers.