Aligning Capacity Decisions in Supply Chains When Demand Forecasts Are Private Information: Theory and Experiment

37 Pages Posted: 1 Feb 2010 Last revised: 17 Apr 2012

See all articles by Kyle B. Hyndman

Kyle B. Hyndman

University of Texas at Dallas

Santiago Kraiselburd

MIT Zaragoza International Logistics Program; INCAE Business School

Noel Watson

Harvard University - Technology & Operations Management Unit

Date Written: January 25, 2010

Abstract

We study the coordination problem of a two-firm supply chain in which firms simultaneously choose a capacity before demand is realized. We focus on the role that (a lack of) common knowledge of demand forecasts has on firms' ability to align their capacity decisions. When forecasts are not common knowledge, there are at most two equilibria: A complete coordination failure or a monotone equilibrium in which firms earn strictly positive profits. The former equilibrium always exists, while the latter exists only when the marginal cost of capacity is sufficiently low. In the monotone equilibrium, capacities are misaligned with probability 1 and profits are lower than in the efficient equilibrium of the common knowledge game. We also show that firms have an incentive to share their information. In a series of experiments, we test the model's predictions. We find that: (1) most subjects use monotone strategies and those that do not earn significantly less; (2) when forecasts are not common knowledge, alignment often suffers, though profits do not; (3) information sharing improves earnings through greater accuracy and alignment; and (4) subjects learn to align their decisions, and earnings increase, over time.

Keywords: Common Knowledge, Coordination, Newsvendor

JEL Classification: M21

Suggested Citation

Hyndman, Kyle B. and Kraiselburd, Santiago and Watson, Noel, Aligning Capacity Decisions in Supply Chains When Demand Forecasts Are Private Information: Theory and Experiment (January 25, 2010). Available at SSRN: https://ssrn.com/abstract=1545445 or http://dx.doi.org/10.2139/ssrn.1545445

Kyle B. Hyndman (Contact Author)

University of Texas at Dallas ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

Santiago Kraiselburd

MIT Zaragoza International Logistics Program ( email )

Avenida Gomez Laguna 25
Zaragoza, 50009
Spain

INCAE Business School

Alajuela
Costa Rica

HOME PAGE: http://www.incae.edu

Noel Watson

Harvard University - Technology & Operations Management Unit ( email )

Boston, MA 02163
United States

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