Ordering behavior in a supply chain with customers that respond to changes in service level

Abstract

The presence of service-level-dependent demand has been empirically observed in industry and is well-documented in the literature. How does the implicit contractual existence of such service dependency impact the ordering decisions of upstream suppliers? We conduct three controlled laboratory experiments to study the impact a service-reward mechanism may have on the upstream ordering decisions of those charged with inventory ordering decisions. The multistudy approach provides representations of decision dynamics across a variety of scenarios, from one-shot buys to long-term supply-chain relationships. Our combined empirical results consistently suggest that the service-reward mechanism significantly and systematically elevates order levels and order variability in a manner that increases departure from optimal ordering. This effect is observed even when decision-makers have incentives to maintain a steady ordering pattern with their suppliers. Our findings shed much-needed light on individual ordering responses to, and the associated risks of, service-reward mechanisms.