The effect of payment timing on inventory decisions in a newsvendor experiment

Start: 04/07/2011 - 4:15pm
End  : 04/07/2011 - 5:15pm

Statistics/OR/Math Finance Seminar

Jordan Tong, Duke


In the newsvendor problem, a decision maker chooses an inventory order quantity prior to the realization of a random demand. The decision maker faces a trade-off between ordering too many and having leftover inventory versus ordering too few and missing out on potential sales. Keeping the net profit structure constant, we study how the timing of the payments affects the inventory decisions. Specifically, we examine three payment schemes which can be interpreted as the inventory order being financed 1) by the newsvendor herself, 2) by the supplier, and 3) by the customer. Models that are neutral with respect to the payment timings, such as risk aversion, risk seeking, and other static utility preferences, would predict the same ordering behavior across the three payment schemes. On the contrary, we find in laboratory experiments that ordering decisions are significantly different across the three payment schemes. Specifically, the order quantity under newsvendor own financing is greater than that under supplier financing, which is, in turn, greater than the order quantity under customer financing. These findings are also in disagreement with what a regular or hyperbolic time-discounted utility model would predict. Instead, we propose a model of underweighting order-time payments based on the principles of mental accounting and show that the experimental results are consistent with this new model. We further validate the robustness of our model under different profit-margin conditions. Our findings contribute to the understanding of the psychological processes involved in newsvendor decisions and have implications for supply chain financing practices such as trade credit and supply chain contract design. This is joint work with Li Chen and Gurhan Kok. Duke University: The Fuqua School of Business.

Harvey Mudd College on the 3rd floor the Sprague library. Refreshments at 4pm.