Jordan D. Tong

The Effect of Payment Schemes on Inventory Decisions: The Role of Mental Accounting

Does the payment scheme have an effect on inventory decisions in the newsvendor problem? Keeping the net profit structure constant, we examine three payment schemes that can be interpreted as the newsvendors order being financed by the newsvendor herself scheme O, by the supplier through delayed order payment scheme S, and by the customer through advanced revenue scheme C. In a laboratory study, we find that inventory quantities exhibit a consistent decreasing pattern in the order of schemes O, S, and C, with the order quantities of scheme S being close to the expected-profit-maximizing solution. These observations are inconsistent with the expected-profit-maximizing model, contradict what a regular or hyperbolic time-discounting model would predict, and cannot be explained by the loss aversion model. Instead, they are consistent with a model that underweights the order-time payments, which can be explained by the “prospective accounting” theory in the mental accounting literature. A second study shows that the results hold even if all physical payments are conducted at the same time, suggesting that the framing of the payment scheme is sufficient to induce the prospective accounting behavior. We further validate the robustness of our model under different profit conditions. Our findings contribute to the understanding of the psychological processes involved in newsvendor decisions and have implications for supply chain financing and contract design. This paper was accepted by Christian Terwiesch, operations management.

Payment Timing in Multiechelon Supply Chains: Cost Assessment, Incentives, and Coordination

Advanced information technologies are increasing the variety of payment triggers between supply chain stages. The cost assumptions made by standard multiechelon inventory models, however, do not have the flexibility to account for these rapid changes. We take one step towards closing this gap by focusing on common payment triggers used with wholesale prices. We introduce a notation system to explicitly connect physical and financial flows so that payment streams can be expressed as functions of standard physical inventory metrics. We then derive a new cost formulation that captures the financial inventory cost implications of such payment streams. These tools are powerful because they dramatically increase the usability and adaptability of existing multiechelon inventory models, under both traditional and more general payment terms. To illustrate, we apply these methods to derive insights on three supply chain topics in a two-echelon base stock model. First, we examine how wholesale prices affect competitive inventory policies and supply chain efficiency under standard payment terms – showing that the cost of decentralization is not only due to too little inventory at the retailer, but also to too much inventory at the supplier. Second, we explore consignment as a possible coordination mechanism – showing that full consignment causes the supplier to overly restrict the inventory at the retailer, but partial consignment can achieve coordination. Third, we study the impact of unequal costs of capital between supply chain members - providing insight into when extending lower capital cost rates to supply chain partners is beneficial.

Good Choice, Bad Judgment: How Choice Under Uncertainty Generates Overoptimism:

We examine a fundamental feature of choice under uncertainty: Overestimating an alternative makes one more likely to choose it. If people are naive to this structural feature, then they will tend to have erroneously inflated expectations for the alternatives they choose. In contrast to theories of motivated reasoning, this theory suggests that individuals will overestimate chosen alternatives even before they make their choice. In four studies, we found that students and managers exhibited behavior consistent with naïveté toward this relationship between estimation error and choice, leaving them overoptimistic about their chosen alternatives. This overoptimism from choosing positive error is exacerbated when the true values of the alternatives are close together, when there is more uncertainty about the values of alternatives, and when there are many alternatives to choose from. Our results illustrate how readily overoptimism emerges as a result of statistical naïveté, even in the absence of a desire to justify one’s decision after the choice.

A Behavioral Remedy for the Censorship Bias

Existing evidence suggests that managers exhibit a censorship bias: demand beliefs tend to be biased low when lost sales from stockouts are unobservable (censored demand) compared to when they are observable (uncensored demand). By leveraging psychological theory on wicked environments, we develop a non-constraining, easily-implementable behavioral debias technique to help mitigate this tendency in an inventory decision-making setting. The debiasing technique has individuals record estimates of demand observations (REDO): participants explicitly record a self-generated estimate of the demand realization in every period, regardless of whether or not a stockout occurs. In doing so, they construct a more representative sample of demand realizations (that differs from the sales sample). In two laboratory experiments with MBA and undergraduate students, this remedy significantly reduces downward bias in demand beliefs under censorship and leads to higher inventory order decisions.

Good Choice, Bad Judgment: How Choice Under Uncertainty Generates Overoptimism

We examine a fundamental feature of choice under uncertainty: Overestimating an alternative makes one more likely to choose it. If people are naive to this structural feature, then they will tend to have erroneously inflated expectations for the alternatives they choose. In contrast to theories of motivated reasoning, this theory suggests that individuals will overestimate chosen alternatives even before they make their choice. In four studies, we found that students and managers exhibited behavior consistent with naivety toward this relationship between estimation error and choice, leaving them overoptimistic about their chosen alternatives. This overoptimism from choosing positive error is exacerbated when the true values of the alternatives are close together, when there is more uncertainty about the values of alternatives, and when there are many alternatives to choose from. Our results illustrate how readily overoptimism emerges as a result of statistical naivety, even in the absence of a desire to justify one’s decision after the choice.

Modeling Payment Timing in Multiechelon Inventory Systems with Applications to Supply Chain Coordination

Advanced information technologies are increasing the variety of payment triggers between supply chain stages. The cost assumptions made by standard multiechelon inventory models, however, do not have the flexibility to account for these rapid changes. We take one step towards closing this gap by focusing on common payment triggers used with wholesale prices. We introduce a notation system to explicitly connect physical and financial flows so that payment streams can be expressed as functions of standard physical inventory metrics. We then derive a new cost formulation that captures the financial inventory cost implications of such payment streams. These tools are powerful because they dramatically increase the usability and adaptability of existing multiechelon inventory models, under both traditional and more general payment terms. To illustrate, we apply these methods to derive insights on three supply chain topics in a two-echelon base stock model. First, we examine how wholesale prices affect competitive inventory policies and supply chain efficiency under standard payment terms – showing that the cost of decentralization is not only due to too little inventory at the retailer, but also to too much inventory at the supplier. Second, we explore consignment as a possible coordination mechanism – showing that full consignment causes the supplier to overly restrict the inventory at the retailer, but partial consignment can achieve coordination. Third, we study the impact of unequal costs of capital between supply chain members - providing insight into when extending lower capital cost rates to supply chain partners is beneficial.

Payment Terms and Wholesale Prices in Multiechelon Supply Chains: Cost Assessment, Incentives, and Coordination

Advanced information technologies are increasing the variety of payment triggers between supply chain stages. The cost assumptions made by standard multiechelon inventory models, however, do not have the flexibility to account for these rapid changes. We take one step towards closing this gap by focusing on common payment triggers used with wholesale prices. We introduce a notation system to explicitly connect physical and financial flows so that payment streams can be expressed as functions of standard physical inventory metrics. We then derive a new cost formulation that captures the financial inventory cost implications of such payment streams. These tools are powerful because they dramatically increase the usability and adaptability of existing multiechelon inventory models, under both traditional and more general payment terms. To illustrate, we apply these methods to derive insights on three supply chain topics in a two-echelon base stock model. First, we examine how wholesale prices affect competitive inventory policies and supply chain efficiency under standard payment terms – showing that the cost of decentralization is not only due to too little inventory at the retailer, but also to too much inventory at the supplier. Second, we explore consignment as a possible coordination mechanism – showing that full consignment causes the supplier to overly restrict the inventory at the retailer, but partial consignment can achieve coordination. Third, we study the impact of unequal costs of capital between supply chain members - providing insight into when extending lower capital cost rates to supply chain partners is beneficial.