Credible Cheap-Talk Communication of Private Demand Information on Both the Forecast Average and Accuracy

A canonical setting in supply chain research is one in which a retailer sources a product, under a wholesale price contract, from a manufacturer that invests in capacity in advance of the retailer’s order. When the retailer possesses private information about demand, it is well understood that credible cheap-talk communication is not possible absent considerations of trust or the reactive setting of the wholesale price. This understanding is based on the practice of demand information being shared as a point forecast. Motivated by the fact that some firms are now sharing information on forecast uncertainty along with the mean, we revisit the canonical setting but allow the retailer to communicate its average demand and its forecast accuracy and allow the manufacturer to have multiple sources of capacity. We establish that credible and informative communication emerges in equilibrium under very general conditions. Moreover, when the manufacturer has multiple sources of capacity that differ in reservation and execution costs, the communication can be influential, strictly improve the manufacturer’s expected profit, and result in a Pareto improvement of supply chain profits. Our results suggest that both the forecast average and accuracy should be communicated in a supply chain not only because upstream firms benefit from a quantification of uncertainty but because communicating information about forecast accuracy (in addition to average demand) enhances the credibility of communication. We establish that improvements to the manufacturer’s capacity portfolio (e.g., expansion or cost reduction) can hurt the manufacturer because of an associated reduction in information revelation. This negative effect can occur if the improvement alters or impacts the resource that, in isolation, provides the highest optimal service level.