The Effect of Behavioral Biases on Supply Chain Decisions

Abstract

Traditional work in operations management has focused on topics such as supply chain contracts and pricing, studying design of efficient contracts and optimal pricing policies. After these optimal solutions and recommendations are derived, they must be implemented properly by managers in practice. Because this process is subject to behavioral decision biases, work in behavioral operations management has begun to connect theories of decision biases to behavior in classical operations management. My dissertation focuses in this area by studying how decisions are made by suppliers and retailers in B2B settings. In essay one, I investigate the effect of effort-dependent demand on supply chain contracts. It is found that the actual cost of effort affects the retailer's optimal level of effort and subsequently determines when a supplier should prefer a wholesale price contract to a buyback contract. As the retailer's cost of effort increases, the retailer's optimal level of effort decreases, leading the supplier to prefer the wholesale price contract. It is verified experimentally that retailer and supplier decisions are driven by cost of retailer effort. Furthermore, I demonstrate that suppliers' contract preferences are influenced by effort cost, not expected profit. In essay two, I look at the link between two supply chain decisions that have previously not been connected before. In this this essay, I study how the contract type (wholesale price or buyback) offered to the retailer affects his decision about which product to stock, particularly when one product is obviously riskier than another. I find, experimentally, that while contract type should make no difference in preferences between a safe and risky product, the retailer displays markedly different preferences arcoss contract type. I propose that this difference in preference structure can be explained by a model that incorporates a Prospect Theory weighting function. Finally, I demonstrate experimentally that this behavioral model of choice explains retailer product choice both when making the isolated product choice decision and the joint product/quantity decision.