The impact of strategic consumer behavior on the value of operational flexibility

Abstract

Increasingly sophisticated consumers have learned to anticipate future price reductions and forego purchasing products until such markdowns occur. Such forward-looking or strategic behavior on the part of consumers can have a significant impact on retail margins by shifting a large number of sales from higher, “full” prices to lower, “clearance” prices. Some firms, however, have become adept at dealing with the strategic consumer problem by implementing various forms of operational flexibility (for example, investing in faster supply chains capable of rapidly responding to changing demand conditions). A firm famous for this strategy is the Spanish fashion retailer Zara. In this chapter, we explore the strategic consumer purchasing phenomenon, and in particular address how the Zara model of operational flexibility impacts consumer behavior (and, conversely, how consumer behavior impacts the value of operational flexibility). We examine in detail the consequences of volume flexibility - the ability of a firm to adjust production or procurement levels to meet stochastic demand - and demonstrate that this type of flexibility can be highly effective at reducing the extent of strategic behavior. Indeed, we show that in many cases, the value of volume flexibility is greater when consumers are strategic than when they are not. We also show that volume flexibility is always socially optimal (i.e., it increases the total welfare of the firm and consumers) and may also improve consumer welfare (i.e., it can be a Pareto improving strategy). We also discuss the impact of other types of operational flexibility - design flexibility, in which a product’s design can be modified to suit changing consumer tastes, and mix flexibility, in which production capacity can be dynamically allocated among several similar product variants - and argue that these types of flexibility are also effective at mitigating strategic customer purchasing behavior.