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Risk pooling has been studied extensively in the operations management literature as the basic driver behind strategies such as transshipment, manufacturing flexibility, component commonality, and drop shipping. This paper explores the benefit of risk pooling in the context of inventory management using the canonical model first studied in Eppen [Eppen GD (1979) Effects of centralization on expected costs in a multi-location newsboy problem. Management Sci. 25(5):498-501]. Specifically, we consider a single-period, multilocation newsvendor model, where n different locations face independent and identically distributed demands and linear holding and backorder costs. We show that Eppen's celebrated result, i.e., that the expected cost savings from centralized inventory management scale with the square root of the number of locations, depends critically on the 'light- tailed' nature of the demand uncertainty. In particular, we establish that the benefit from pooling relative to the decentralized case, in terms of both expected cost and safety stock, is equal to for a class of heavy tailed demand distributions (stable distributions), whose power-law asymptotic decay rate is determined by the parameter α ∈ (1, 2). Thus, the benefit from pooling under heavy-tailed demand uncertainty can be significantly lower than [square root of n], which is predicted for normally distributed demands. We discuss the implications of this result on the performance of periodic-review policies in multiperiod inventory management, as well as for the profits associated with drop-shipping fulfillment strategies. Corroborated by an extensive simulation analysis with heavy-tailed distributions that arise frequently in practice, such as power law and log normal, our findings highlight the importance of taking into account the shape of the tail of demand uncertainty when considering a risk pooling initiative. Keywords: inventory management; inventory pooling; demand uncertainty; heavy-tailed distributions History: Received May 18, 2014; accepted February 27, 2015, by Serguei Netessine, operations management. Published online in Articles in Advance October 30, 2015., 1. Introduction One of the primary goals of an inventory management system is to protect the firm against demand uncertainty. Inventory pooling, i.e., the practice of serving multiple markets from [...]

We characterize the equilibrium behavior in a broad class of competition models in which the competing firms' market shares are given by an attraction model, and the aggregate sales in the industry depend on the aggregate attraction value according to a general function. Each firm's revenues and costs are proportional with its expected sales volume, with a cost rate that depends on the firm's chosen attraction value according to an arbitrary increasing function. Whereas most existing competition papers with attraction models can be viewed as special cases of this general model, we apply our general results to a new set of quality competition models. Here an industry has N suppliers of a given product, who compete for the business of one or more buyers. Each of the suppliers encounters an uncertain yield factor, with a given general yield distribution. The buyers face uncertain demands over the course of a given sales season. The suppliers compete by selecting key characteristics of their yield distributions, either their means, their standard deviations, or both. These choices have implications for their per-unit cost rates. Key words: inventory production; uncertainty; games-group decisions; stochastic models History: Received October 12, 2007; accepted April 25, 2009, by Paul H. Zipkin, operations and supply chain management. Published online in Articles in Advance October 16, 2009., 1. Introduction and Summary Starting with a seminal paper by Friedman (1958), there is a well-established tradition in the economics, marketing, and operations literature to model competition in oligopolies by [...]

A key question for Internet commerce is the nature of competition with traditional brick-and-mortar retailers. Although traditional retailers vastly outsell Internet retailers in most product categories, research on Internet retailing has largely neglected this fundamental dimension of competition. Is cross-channel competition significant, and if so, how and where can Internet retailers win this battle? This paper attempts to answer these questions using a unique combination of data sets. We collect data on local market structures for traditional retailers, and then match these data to a data set on consumer demand via two direct channels: Internet and catalog. Our analyses show that Internet retailers face significant competition from brick-and-mortar retailers when selling mainstream products, but are virtually immune from competition when selling niche products. Furthermore, because the Internet channel sells proportionately more niche products than the catalog channel, the competition between the Internet channel and local stores is less intense than the competition between the catalog channel and local stores. The methods we introduce can be used to analyze cross-channel competition in other product categories, and suggest that managers need to take into account the types of products they sell when assessing competitive strategies. Key words: Internet markets; electronic commerce; cross-channel; competition; retailing; channel; niche products; geography; long tail History: Received March 27, 2008; accepted May 15, 2009, by Ramayya Krishnan, information systems. Published online in Articles in Advance August 27, 2009., 1. Introduction Our primary competitors are brick-and-mortar, so we have to be really responsive from a fulfillment standpoint. More and more, we're going to be competing with the guy down [...]

The phenomenon of sponsored search advertising--where advertisers pay a fee to Internet search engines to be displayed alongside organic (nonsponsored) Web search results--is gaining ground as the largest source of revenues for search engines. Using a unique six-month panel data set of several hundred keywords collected from a large nationwide retailer that advertises on Google, we empirically model the relationship between different sponsored search metrics such as click-through rates, conversion rates, cost per click, and ranking of advertisements. Our paper proposes a novel framework to better understand the factors that drive differences in these metrics. We use a hierarchical Bayesian modeling framework and estimate the model using Markov Chain Monte Carlo methods. Using a simultaneous equations model, we quantify the relationship between various keyword characteristics, position of the advertisement, and the landing page, quality score on consumer search and purchase behavior as well as on advertiser's cost per click and the search engine's ranking decision. Specifically, we find that the monetary value of a click is not uniform across all positions because conversion rates are highest at the top and decrease with rank as one goes down the search engine results page. Though search engines take into account the current period's bid as well as prior click-through rates before deciding the final rank of an advertisement in the current period, the current bid has a larger effect than prior click-through rates. We also find that an increase in landing page quality scores is associated with an increase in conversion rates and a decrease in advertiser's cost per click. Furthermore, our analysis shows that keywords that have more prominent positions on the search engine results page, and thus experience higher click-through or conversion rates, are not necessarily the most profitable ones--profits are often higher at the middle positions than at the top or the bottom ones. Besides providing managerial insights into search engine advertising, these results shed light on some key assumptions made in the theoretical modeling literature in sponsored search. Key words: online advertising; search engines; hierarchical Bayesian modeling; paid search; click-through rates; conversion rates; keyword ranking; cost per click; electronic commerce; Internet monetization History: Received August 30, 2007; accepted April 14, 2009, by Jagmohan S. Raju marketing. Published online in Articles in Advance July 27, 2009., 1. Introduction The Internet has brought about a fundamental change in the way users generate and obtain information, thereby facilitating a paradigm shift in consumer search and purchase patterns. In [...]

This paper develops a test of the asymptotic arbitrage pricing theory (APT) via the maximum squared Sharpe ratio of the factors extracted from individual stocks using the Connor-Korajczyk method. The test treats the beta pricing relation as approximate without predetermining the systematic factors, unlike the existing tests that take the relationship as exact and systematic factors as given. This paper also examines the magnitude of pricing errors bounded partly by the maximum squared Sharpe ratio. For most 60-month subperiods of the sample, the hypothesis that the maximum squared Sharpe ratio for monthly returns is greater than 0.25 can be rejected. Simulation indicates that the average pricing error in monthly returns is less than 0.001. These results support the asymptotic APT. Key words: asymptotic APT; beta pricing errors; Sharpe ratio; Connor-Korajczyk method; eigenvalue; eigenvector History: Received October 16, 2007; accepted January 23, 2009, by David A. Hsieh, finance. Published online in Articles in Advance April 23, 2009., 1. Introduction The mainstream asset pricing models, i.e., the capital asset pricing model (CAPM) developed by Sharpe (1964), the intertemporal capital asset pricing models by Merton (1973), and the arbitrage [...]

This paper quantifies the effect of state privacy regulation on the diffusion of electronic medical records (EMRs). EMRs allow medical providers to store and exchange patient information using computers rather than paper records. Hospitals may be more likely to adopt EMRs if they can reassure patients that their confidentiality is legally protected. Alternatively, privacy protection may inhibit adoption if hospitals cannot benefit from easily exchanging patient information. We find that state privacy regulation restricting hospital release of health information reduces aggregate EMR adoption by hospitals by more than 24%. We present evidence that suggests that this is due to the suppression of network externalities. Key words: technology; privacy protection; health IT; network externalities; network effects; hospitals History: Received May 2, 2008; accepted February 16, 2009, by Ramayya Krishnan, information systems. Published online in Articles in Advance May 7, 2009., 1. Introduction Electronic medical records (EMRs) allow medical providers to store and exchange medical information using computers rather than paper records. Although EMRs were invented in the 1970s, by 2005 [...]

People are more willing to bet on their own judgments when they feel skillful or knowledgeable. We investigate whether this "competence effect" influences trading frequency and home bias. We find that investors who feel competent trade more often and have more internationally diversified portfolios. We also find that male investors, and investors with larger portfolios or more education, are more likely to perceive themselves as competent than are female investors, and investors with smaller portfolios or less education. Our paper also contributes to understanding the theoretical link between overconfidence and trading frequency. Existing theories on trading frequency have focused on one aspect of overconfidence, i.e., miscalibration. Our paper offers a potential mechanism for the "better-than-average" aspect of overconfidence to influence trading frequency. In the context of our paper, overconfident investors tend to perceive themselves to be more competent, and thus are more willing to act on their beliefs, leading to higher trading frequency. Key words: behavioral finance; investment; competence; ambiguity; stock trading frequency; home bias History: Received June 25, 2007; accepted January 25, 2009, by Neal Stoughton (guest department editor), finance. Published online in Articles in Advance April 23, 2009., 1. Introduction We argue that "investor competence" ties together two important puzzles in international and financial economics--the home bias problem (too little is invested outside of the home market) and [...]

This paper examines the effect of recommender systems on the diversity of sales. Two anecdotal views exist about such effects. Some believe recommenders help consumers discover new products and thus increase sales diversity. Others believe recommenders only reinforce the popularity of already-popular products. This paper seeks to reconcile these seemingly incompatible views. We explore the question in two ways. First, modeling recommender systems analytically allows us to explore their path-dependent effects. Second, turning to simulation, we increase the realism of our results by combining choice models with actual implementations of recommender systems. We arrive at three main results. First, some well-known recommenders can lead to a reduction in sales diversity. Because common recommenders (e.g., collaborative filters) recommend products based on sales and ratings, they cannot recommend products with limited historical data, even if they would be rated favorably. In turn, these recommenders can create a rich-get-richer effect for popular products and vice versa for unpopular ones. This bias toward popularity can prevent what may otherwise be better consumer-product matches. That diversity can decrease is surprising to consumers who express that recommendations have helped them discover new products. In line with this, result two shows that it is possible for individual-level diversity to increase but aggregate diversity to decrease. Recommenders can push each person to new products, but they often push users toward the same products. Third, we show how basic design choices affect the outcome, and thus managers can choose recommender designs that are more consistent with their sales goals and consumers' preferences. Key words: IT policy and management; electronic commerce; application contexts/sectors; IT impacts on industry and market structure; marketing; advertising and media History: Received June 21, 2007; accepted November 18, 2008, by Barrie Nault, information systems. Published online in Articles in Advance March 6, 2009., 1. Introduction Media has historically been a 'blockbuster' industry (Anderson 2006). Of the many products available, sales have concentrated among a small number of hits. In recent years, such concentration [...]

It is commonly argued that in recent years pharmaceutical companies have targeted their research and development (R&D) at small improvements of existing compounds instead of riskier drastic innovations. In this paper, we show that the bias in the pharmaceutical industry toward small innovations might be driven by the low sensitivity of the demand. In particular, small innovations get a proportionally larger reward because pharmaceutical firms target them at the inelastic segments of the demand. As a consequence, firms find it relatively more profitable to invest in small innovations. We also study the effect on R&D incentives of marketing strategies and regulatory instruments aimed at controlling pharmaceutical expenditure. Key words: health care; pharmaceuticals; innovation; marketing History: Received June 21, 2006; accepted October 20, 2008, by Pankaj Ghemawat, business strategy. Published online in Articles in Advance January 28, 2009., 1. Introduction In most developed countries, the pharmaceutical industry channels an important proportion of total research and development (R&D). In Europe, for example, it represents about 13% of total research [...]

Ranking and selection procedures are standard methods for selecting the best of a finite number of simulated design alternatives based on a desired level of statistical evidence for correct selection. But the link between statistical significance and financial significance is indirect, and there has been little or no research into it. This paper presents a new approach to the simulation selection problem, one that maximizes the expected net present value of decisions made when using stochastic simulation. We provide a framework for answering these managerial questions: When does a proposed system design, whose performance is unknown, merit the time and money needed to develop a simulation to infer its performance? For how long should the simulation analysis continue before a design is approved or rejected? We frame the simulation selection problem as a 'stoppable' version of a Bayesian bandit problem that treats the ability to simulate as a real option prior to project implementation. For a single proposed system, we solve a free boundary problem for a heat equation that approximates the solution to a dynamic program that finds optimal simulation project stopping times and that answers the managerial questions. For multiple proposed systems, we extend previous Bayesian selection procedures to account for discounting and simulation-tool development costs. Key words: simulation; ranking and selection; economics of simulation; optimal stopping; free boundary problem History, Accepted by Michael Fu, stochastic models and simulation; received January 8, 2008. This paper was with the authors 3 months for 2 revisions. Published online in Articles in Advance November 26, 2008., Managers must decide the operating characteristics of their companies' manufacturing, supply chain, or service delivery systems. Often the decision reflects the choice of one among a number of competing designs. [...]

Consider an inventory system with multiple supply sources and Poisson demand. The replenishment lead times from each source are stochastic, representing congestion and disruption. We develop performance evaluation and optimization tools for a family of reasonable order policies. These policies take into account real-time supply information, which can be obtained through tracking technologies such as global positioning systems and radio frequency identification. Performance evaluation of such state-dependent policies is generally hard. The main thrust of this paper is to show that, under these policies, the supply system becomes a network of queues with a special routing mechanism called an overflow bypass. The solution has a simple product form. Thus, we obtain closed-form performance measures. These results reinterpret and extend the existing analysis of a system with two sources having deterministic lead times. We further extend the analysis to batch ordering policies, non-Poisson demand processes, and multiple demand classes. Key words: inventories; multiple supply sources; stochastic lead times; queuing networks; product-form solutions. History: Accepted by Michael Fu, stochastic models and simulation; received June 1, 2007. This paper was with the authors 6 1/2 months for 2 revisions. Published online in Articles in Advance November 24, 2008., 1. Introduction Consider an inventory system that is standard in most ways (continuous time, Poisson demand, linear order costs), but has two supply sources, a normal one and a faster, [...]

Preference between two future outcomes may change over time--a phenomenon labeled as time inconsistency The term 'time inconsistency' is usually used to refer to cases in which a larger-later outcome is preferred over a smaller-sooner one when both are delayed by some time, but then with the passage of time a preference switches to the smaller-sooner outcome. The current paper presents four empirical studies showing that time inconsistency in the other direction is also possible: A person may prefer the smaller-sooner outcome when both options are in the future, but decide to wait for the larger-later one when the smaller option becomes immediately available. We find that such 'reverse time inconsistency' is more likely to be observed when the delays to and between the two outcomes are short (up to a week). We propose that reverse time inconsistency may be associated with a reversed-S shape discount function, and provide evidence that such a discount function captures part of the variation in intertemporal preferences. Key words: time inconsistency; reverse time inconsistency; time preference; intertemporal preferences History: Accepted by George Wu, decision analysis; received April 28, 2006. This paper was with the authors 1 year and 6 1/2 months for 4 revisions. Published online in Articles in Advance December 17, 2008., 1. Introduction An individual's preference for a particular future outcome over another one may change with the passage of time. Usually, the term time inconsistency (TI) (or dynamic inconsistency) is [...]

This paper examines complementarity among vertical integration decisions in automobile product development. Though most research assumes that contracting choices are independent of each other, contracting complementarity arises when the returns to a single vertical integration decision are increasing in the level of vertical integration associated with other contracting choices. First, effective coordination may depend on the level of (noncontractible) effort on the part of each agent; contracting complementarity results if coordination efforts are interdependent and vertical integration facilitates a higher level of noncontractible effort. Second, effective coordination may require the disclosure of proprietary trade secrets, and the potential for expropriation by external suppliers may induce complementarity among vertical integration choices. We provide evidence for complementarity in product development contracting by taking advantage of a detailed data set that includes the level of vertical integration and the contracting environment for individual automobile systems in the luxury automobile segment. Using an instrumental variables framework that distinguishes complementarity from unobserved firm-level factors, the evidence is consistent with the hypothesis that contracting complementarity is an important driver of vertical integration choices. The findings suggest that contracting complementarity may be particularly important when coordination is important to achieve but difficult to monitor. Keywords: vertical integration; automobile industry; complementarity; outsourcing strategies; product development History: Accepted by Pankaj Ghemawat, business strategy; received October 12, 2004. This paper was with the authors 1 year and 10 months for 1 revision. Published online in Articles in Advance November 24, 2008., 1. Introduction The modern theory of the firm has made considerable progress in explaining the determinants of vertical integration and firm boundaries, assuming that the level of vertical integration results [...]

Conditional value at risk (CVaR) is both a coherent risk measure and a natural risk statistic. It is often used to measure the risk associated with large losses. In this paper, we study how to estimate the sensitivities of CVaR using Monte Carlo simulation. We first prove that the CVaR sensitivity can be written as a conditional expectation for general loss distributions. We then propose an estimator of the CVaR sensitivity and analyze its asymptotic properties. The numerical results show that the estimator works well. Furthermore, we demonstrate how to use the estimator to solve optimization problems with CVaR objective and/or constraints, and compare it to a popular linear programming-based algorithm. Key words: simulation; statistical analysis; applications; portfolio History: Accepted by Michael Fu, stochastic models and simulation; received August 19, 2007. This paper was with the authors 3 weeks for 4 revisions. Published online in Articles in Advance September 5, 2008., 1. Introduction Value at risk (VaR) and conditional value at risk (CVaR) are two widely used risk measures. The α-VaR of a random loss L is the α quantile of [...]

This paper discusses the notion of workflow congestion in the context of material handling equipment interruptions in a manufacturing or warehousing facility. Development of a combination of probabilistic and physics-based models for workflow interruptions permits evaluation of the expected link travel time. The problem is then of routing in a way that minimizes total expected travel time. The rerouting problem is modeled as a multicommodity flow problem with link capacity design. A greedy upper bounding and Lagrangean relaxation algorithm are developed to solve this efficiently. To calibrate our modeling process we develop an object-oriented simulation model that explicitly considers various workflow interruptions. Our major finding is that rerouting traffic in a congested facility can significantly alleviate congestion delays and improve the efficiency of material movement. A managerial insight derived from this work is that rerouting is most effective in medium traffic-intensity situations. Key words: facility design; workflow congestion History: Accepted by Ananth lyer, operations and supply chain management; received September 6, 2007. This paper was with the authors 1 1/2 weeks for 1 revision. Published online in Articles in Advance October 10, 2008., 1. Introduction and Motivation Workflow congestion is a major concern in a facility because it results in immediate safety problems: damaged uprights, damaged vehicles; and damaged workers (Tompkins et al. [...]

This paper analyzes a waiting line system that is motivated by the operations of border-crossing stations between the United States and Canada. There are two main conflicting goats in such a system: high security level, which often leads to a longer line; and good customer service, which requires a shorter line. Thus, unlike other queueing systems, maintaining the average queue length within a certain range is the primary objective. This is achieved using a staffing policy, called 'congestion-based staffing,' or CBS, where the number of servers (inspection booths) is adjusted according to the queue length during a planning period. We first present an exact benchmark model of Markovian type based on the matrix-geometric solution. For practical CBS policies, we develop a set of closed-form formulas for the major performance measures based on regenerative cycle analysis and fluid limit approximation. Numerical examples show that these approximation formulas are simple, accurate, and robust for practitioners to use in designing CBS policies. Key words: congestion-based staffing; matrix-geometric solution; regeneration cycle; fluid limits approximation; Markovian queues; (e, n, N) policy; border-crossing station History: Accepted by Michael Fu, stochastic models and simulation; received November 19, 2007. This paper was with the author 3 weeks for 3 revisions. Published online in Articles in Advance September 30, 2008., 1. Introduction The study in this paper was motivated by waiting lines at the United States and Canada border crossings observed by the author between Washington State and the province [...]

We analyze the allocation of objects in a network of caches that coliaborate to service requests from customers. A thorough analysis of this problem in centralized and decentralized setups, both of which occur in practice, is essential for understanding the benefits of collaboration. A key insight offered by this paper is that an efficient implementation of cooperative cache management is possible because, in the centralized scenario, the object allocation resulting in the best social welfare can be found easily as a solution to a transportation problem. For the decentralized scenario involving selfish caches, it is shown that pure equilibria exist and that the cache network always reaches a pure equilibrium in a finite number of steps, starting from any point in the strategy space. An auction mechanism is developed to derive prices that motivate the caches to hold objects in a manner such that the optimal social welfare is attained. In the special case of symmetric caches, simple algorithms are devised to find the optimal social welfare allocation, the best pure equilibrium, and the prices for sharing objects. The results obtained in this paper should be valuable in developing and evaluating cache-management policies. Resource-sharing problems with a similar cost structure exist in a variety of other domains, and the insights gained here are expected to extend to those scenarios as well. Key words: collaborative cache management; resource sharing; peer-to-peer network; mathematical programming; game theory. History: Accepted by Barrie Nault, information systems; received May 3, 2006. This paper was with the authors 1 year and 1 month for 3 revisions. Published online in Articles in Advance October 17, 2008., 1. Introduction Caching is the process of replicating Web contents in locations where they can be readily accessed by end users. The objective is to expedite the delivery of the [...]

We investigate how dynamic resource substitution in service systems impacts capacity requirements and responsiveness. Inspired by the contrasting network strategies of FedEx and United Parcel Service (UPS), we study when two service classes (e.g., express or regular) should be served by dedicated resources (e.g., air or ground) or by an integrated network (e.g., air also serves regular). Using call center terminology, the question is whether to operate two independent queues or one N-network. We present analytic expressions for the delay distributions and the value of network integration through partial resource pooling. These show how the value of network integration depends on service quality (speed and reliability of service) and demand characteristics (volume averages and covariance matrix). Our results suggest that network integration is of little value and operating dedicated networks is a fine strategy if the firm primarily serves express requests with high reliability and if the correlation with regular requests is not strongly negative. In contrast, network integration offers significant gains for firms serving primarily regular requests, almost independent of correlation. Our analysis provides the intuition behind these findings in terms of three main drivers of integration value: arrival pooling, the substitution effect, and the correlation effect. Key words: network integration strategy; quality of service; flexible technology; N-network, skill-based routing; queueing History: Accepted by Michael Fu, stochastic models and simulation; received January 26, 2006. This paper was with the authors 1 year and 2 months for 2 revisions. Published online in Articles in Advance October 7, 2008., 1. Introduction and Summary In this paper, we study the value of dynamic resource substitution in service systems. Using a stylized analytic model of a firm that serves two separate [...]

There is an emerging debate in the scholarly literature regarding the extent to which academic human capital contributes to firm performance. This debate centers on the nature of an academic scientist's human capital and its institutional specificity. Using data on the human capital of biomedical scientists developed during their careers in academe, this paper analyzes how the depth of their scientifically and commercially oriented academic human capital contributes to firm performance when these scientists subsequently start or join for-profit firms. We find that the scientific and commercial components of an academic scientist's human capital have differential effects on the performance of research and invention tasks at the firm. We also find that the contribution of an academic scientist to a firm's patent productivity is decreasing with the depth of their scientifically oriented human capital, all else constant. These results support the view that academic human capital is heterogeneous and has an institutional specificity that mediates its value when applied in a commercialization environment. Key words: academic entrepreneurship; SBIR; human capital; commercialization; firm performance History: Accepted by Christoph Loch, R&D and product development; received January 25, 2007. This paper was with the authors 5 1/2 months for 2 revisions. Published online in Articles in Advance October 7, 2008., 1. Introduction To what extent does academic human capital contribute to firm performance? There is an emerging debate in the scholarly literature on this question. One strand of the literature [...]

Our paper shows that the parameters in existing theoretical models of channel substitution such as offline transportation cost, online disutility cost, and the prices of online and offline retailers interact to determine consumer choice of channels. In this way, our results provide empirical support for many such models. In particular, we empirically examine the trade-off between the benefits of buying online and the benefits of buying in a local retail store. How does a consumer's physical location shape the relative benefits of buying from the online world? We explore this problem using data from Amazon.com on the top-selling books for 1,497 unique locations in the United States for 10 months ending in January 2006. We show that when a store opens locally, people substitute away from online purchasing, even controlling for product-specific preferences by location. These estimates are economically large, suggesting that the disutility costs of purchasing online are substantial and that offline transportation costs matter. We also show that offline entry decreases consumers' sensitivity to online price discounts. However, we find no consistent evidence that the breadth of the product line at a local retail store affects purchases. Key words: channel substitution; theory testing; Internet retailing History: Accepted by Barrie R. Nault, information systems; received November 30, 2006. This paper was with the authors 6 months for 3 revisions. Published online in Articles in Advance November 26, 2008., 1. Introduction As of 2006, electronic commerce represented just 3% of total retail sales (U.S. Census Bureau 2007). Online shopping remains a small fraction of retail sales despite the well-known [...]

This paper examines the impact of vertical integration on the dynamics of performance over the automobile product development life cycle. Building on recent work in organizational economics and strategy, we evaluate the relationship between vertical integration and different dimensions of product performance. Outsourcing facilitates access to cutting-edge technology and the use of high-powered performance contracts. Vertical integration allows firms to adapt to unforeseen contingencies and customer feedback, maintain balanced incentives over the life cycle, and develop firm-specific capabilities over time. Together, these effects highlight a crucial trade-off: while outsourcing is associated with higher levels of initial performance, vertical integration will be associated with performance improvement over the product life cycle. We test these ideas using detailed data from the luxury automobile segment, establishing three key results. First, initial performance is declining in the level of vertical integration. Second, the level of performance improvement is significantly increasing in the level of vertical integration. Finally, the impact of vertical integration is mediated by the level of preexisting capabilities, by the salience of opportunities to access external technology leaders, and by the scope for learning over the product life cycle. Together, the findings highlight a strategic governance trade-off between short-term performance and the evolution of firm capabilities. Key words: vertical integration; performance dynamics; contracting costs; knowledge-based view of the firm; automobile industry History: Accepted by Pankaj Ghemawat, business strategy; received June 1, 2006. This paper was with the authors 8 months for 2 revisions., 1. Introduction Recent work in strategy and economics has made considerable theoretical and empirical progress in explaining the determinants of vertical integration and firm boundaries. From a theoretical perspective, transaction [...]

In this paper, we explore how organizations influence the unethical behavior of their employees. Using a unique data set of over three million vehicle emissions tests, we find strong evidence of ethical spillovers from firms to individuals. When inspectors work across different organizations, they adjust the rate at which they pasfvs vehicles to the norms of those with whom they work. These spillovers are strongest at large facilities and corporate chains, and weakest for the large-volume inspectors. These results are consistent with the economics literature on productivity spillovers from organizations and peers and suggest that managers can influence the ethics of employee behavior through both formal norms and incentives. The results also suggest that employees have persistent ethics that limit the magnitude of this influence. These results imply that if ethical conformity is important to the financial and legal health of the organization, managers must be vigilant in their hiring, training, and monitoring to ensure that employee behavior is consistent with firm objectives. Key words: peer effects; spillovers; fraud; corruption; productivity; ethics History: Accepted by Olav Sorenson, organizations and social networks; received May 16, 2007. This paper was with the authors 91/2 months for 2 revisions. Published online in Articles in Advance October 10, 2008., 1. Introduction The influence of organizations on individual behavior has been broadly studied in the economics, sociology, and management literatures. Both theoretical work and empirical research have examined how organizations [...]

Voluntary standard-setting organizations (SSOs) are a common feature of systems industries, where firms supply interoperable components for a shared technology platform. These institutions promote coordinated innovation by providing a forum for collective decision making and a potential solution to the problem of fragmented and overlapping intellectual property rights. This paper examines the economic and technological significance of SSOs by analyzing the flow of citations to a sample of U.S. patents disclosed during the standard-setting process. Our main results show that the age distribution of SSO patent citations is shifted toward later years (relative to an average patent) and that citations increase substantially following standardization. These results suggest that SSOs identify promising technologies and influence their subsequent adoption. Key words: standards; compatibility; platform; intellectual property; patents; cumulative innovation History: Accepted by Christoph Loch, R&D and product development; received August 13, 2007. This paper was with the authors 2 1/2 months for 2 revisions. Published online in Articles in Advance September 30, 2008., 1. Introduction Many products and services are based on interoperable yet independently supplied component technologies. In these markets, coordination is an important part of the innovation process. The book Startup [...]

Classical reasons for carrying inventory include fixed (nonlinear) production or procurement costs, lead times, nonstationary or uncertain supply/demand, and capacity constraints. The last decade has seen active research in supply chain coordination focusing on the role of incentive contracts to achieve first-best levels of inventory. An extensive literature in industrial organization that studies incentives for vertical controls largely ignores the effect of inventories. Does the ability to carry inventory influence the problem of vertical control? Conversely, can inventories arise purely due to incentive effects? This paper explicitly considers both incentives and inventories, and their interplay, in a dynamic model of an upstream firm (supplier) and a downstream firm (buyer) who can carry inventories. In our model, none of the classical reasons for carrying inventory exists. However, as we prove, the buyer's optimal strategy in equilibrium is to carry inventories, and the supplier is unable to prevent this. These inventories arise out of purely strategic considerations not yet identified in the literature, and have a significant impact on the equilibrium solution as well as supplier, buyer, and channel profits. We prove that strategic inventories play a pivotal role under arbitrary contractual structures, general (arbitrary) demand functions and general (finite or infinite) horizon lengths. As one example, two-part tariff contracts do not lead to optimal channel performance, nor can the supplier extract away all of the channel profits, in our dynamic model. Our results imply that firms can and must carry inventories strategically, and that optimal vertical contracts must take the possibility of inventories into account. Key words: contracts; inventories; industrial organization; supply chain coordination History: Accepted by Paul H. Zipkin, operations and supply chain management; received March 15, 2007. This paper was with the authors 3 months for 2 revisions. Published online in Articles in Advance August 8, 2008., 1. Introduction Inventory may be carried for a number of well-documented reasons (cf. Zipkin 2000, Nahmias 2004, Anupindi et al. 2006). First, due to economies of scale in procurement or [...]

This paper derives the properties of the discount rate that should be applied to a public-sector project when the affected population has heterogeneous degrees of impatience. We show that, for any distribution of discount rates, the social discount rate has the following properties: it decreases over time, it is lower than the average of the discount rates in the population, and it converges to the discount rate of the most patient individual in the economy. These properties hold for both constant and decreasing individual discount rates. Finally, we evaluate how changes in the distribution of individual discount rates affect the social discount rate. Key words: social discount rate; hyperbolic discounting; cost-benefit analysis History: Accepted by Linda V. Green, public sector applications; received July 6, 2007. This paper was with the authors 1 1/2 months for 3 revisions. Published online in Articles in Advance May 19, 2008., 1. Introduction The appropriate social discount rate (SDR) to apply in public-sector cost-benefit analyses is a contentious issue. As Weitzman (2001 p. 261) states, 'There does not now exist, nor [...]

This paper studies the impact of strategic customer behavior on supply chain performance. We start with a newsvendor seller facing forward-looking customers. The seller initially charges a regular price but may salvage the leftover inventory at a lower salvage price after random demand is realized. Customers anticipate future sales and choose purchase timing to maximize their expected surplus. We characterize the rational expectations equilibrium, where we find that the seller's stocking level is lower than that in the classic model without strategic customers. We show that the seller's profit can be improved by promising either that quantities available will be limited (quantity commitment) or that prices will be kept high (price commitment). In most cases, both forms of commitment are not credible in a centralized supply chain with a single seller. However, decentralized supply chains can use contractual arrangements as indirect commitment devices to attain the desired outcomes with commitment. Decentralization has generally been associated with coordination problems, but we present the contrasting view that disparate interests within a supply chain can actually improve overall supply chain performance. In particular, with strategic customer behavior, we find that (i) a decentralized supply chain with a wholesale price contract may perform strictly better than a centralized supply chain; (ii) contracts widely studied in the supply chain coordination literature (e.g., markdown money, sales rebates, and buyback contracts) can serve as a commitment device as well as an incentive-coordinating device; and (iii) some of the above contracts cannot allocate profits arbitrarily between supply chain members because of strategic customer behavior. Key words: strategic customer behavior; commitment; supply chains; newsvendor; rational expectations; decentralization History: Accepted by William S. Lovejoy, operations and supply chain management; received December 15, 2005. This paper was with the authors 5 months for 6 revisions. Published online in Articles in Advance July 21, 2008., 1. Introduction Consumers today have largely been trained to wait for sales. This is a general consensus, widely accepted by practitioners and academics alike. Year after year, market research organizations [...]

In an innovation contest, a firm (the seeker) facing an innovation-related problem (e.g., a technical R&D problem) posts this problem to a population of independent agents (the solvers) and then provides an award to the agent that generated the best solution. In this paper, we analyze the interaction between a seeker and a set of solvers. Prior research in economics suggests that having many solvers work on an innovation problem will lead to a lower equilibrium effort for each solver, which is undesirable from the perspective of the seeker. In contrast, we establish that the seeker can benefit from a larger solver population because he obtains a more diverse set of solutions, which mitigates and sometimes outweighs the effect of the solvers' underinvestment in effort. We demonstrate that the inefficiency of the innovation contest resulting from the solvers' underinvestment can further be reduced by changing the award structure from a fixed-price award to a performance-contingent award. Finally, we compare the quality of the solutions and seeker profits with the case of an internal innovation process. This allows us to predict which types of products and which cost structures will be the most likely to benefit from the contest approach to innovation. Key words: innovation; product development; open systems; contests History: Accepted by Christoph Loch, R&D and product development; received October 26, 2006. This paper was with the authors 8 months for 2 revisions. Published online in Articles in Advance July 25, 2008., 1.Introduction Innovation is at the heart of every R&D process. The detailed mechanics of R&D differ widely by industry, reflecting different cost structures, different success rates, and different market rewards, [...]

In this paper, we consider the classical multifare, single-resource (leg) problem in revenue management for the case where demand information is limited. Our approach employs a competitive analysis, which guarantees a certain performance level under all possible demand scenarios. The only information required about the demand for each fare class is lower and upper bounds. We consider both competitive ratio and absolute regret performance criteria. For both performance criteria, we derive the best possible static policies, which employ booking limits that remain constant throughout the booking horizon. The optimal policies have the form of nested booking limits. Dynamic policies, which employ booking limits that may be adjusted at any time based on the history of bookings, are also obtained. We provide extensive computational experiments and compare our methods to existing ones. The results of the experiments demonstrate the effectiveness of these new robust methods. Key words: revenue management; robust optimization; competitive analysis History: Accepted by Candace A. Yano, operations and supply chain management; received July 28, 2006. This paper was with the authors 7 1/2 months for 3 revisions. Published online in Articles in Advance July 10, 2008., 1. Introduction The majority of successful revenue management (RM) implementations rely heavily on the use of demand information. Experts advise against rushing to optimization in RM without first fully implementing [...]

We examine a decentralized supply chain in which a single assembler buys complementary components from n suppliers and assembles the final product in anticipation of demand. Players take actions in the following sequence. First (stage 1), the suppliers form coalitions among themselves. Second (stage 2), the coalitions compete for a position in the negotiation sequence. Finally (stage 3), the coalitions negotiate with the assembler on allocations of the supply chain's profit. We model the multilateral negotiations between the suppliers and the assembler sequentially, i.e., the assembler negotiates with one coalition at a time. Each of these negotiations is modeled using the Nash bargaining concept. Further, in forming coalitions we assume that players are farsighted. We then predict at equilibrium the structure of the supply chain as a function of the players' relative negotiation powers. In particular, we show that the assembler always prefers the outcome where suppliers do not form coalitions. However, when the assembler is weak (low negotiation power) the suppliers join forces as a grand coalition, but when the assembler is powerful the suppliers stay independent, which is the preferred outcome to the assembler. Key words: decentralized assembly systems; Nash bargaining; negotiation power; commitment tactics; farsighted stable coalitions History: Accepted by Candace A. Yano, operations and supply chain management; received October 26, 2005. This paper was with the authors 1 year and 2 months for 4 revisions. Published online in Articles in Advance June 20, 2008., 1. Introduction Consider a decentralized assembly system in which a single assembler buys complementary components from n suppliers and assembles the final product in anticipation of demand in a single [...]

Motivated by models of tenant assignment in public housing, we study approximating deterministic fluid models for overloaded queueing systems having multiple customer classes (classes of tenants) and multiple service pools (housing authorities), each with many servers (housing units). Customer abandonment acts to keep the system stable, yielding a proper steady-state description. Motivated by fairness considerations, we assume that customers are selected for service by newly available servers on a first-come, first-served (FCFS) basis from all classes the corresponding service pools are allowed to serve. In this context, it is challenging to determine stationary routing flow rates between customer classes and service pools. Given those routing flow rates, each single fluid queue can be analyzed separately using previously established methods. Our ability to determine the routing flow rates depends on the structure of the network routing graph. We obtain the desired routing flow rates in three cases: when the routing graph is (i) a tree (sparsely connected), (ii) complete bipartite (fully connected), and (iii) an appropriate combination of the previous two cases. Other cases remain unsolved. In the last two solved cases, the routing flow rates are actually not uniquely determined by the fluid model, but become so once we make stochastic assumptions about the queueing models that the fluid model approximates. Key words: deterministic fluid models; service networks; many-server queues; customer abandonment; overloaded queues; tenant assignment in public housing History: Accepted by Michael Fu, stochastic models and simulation; received March 20, 2007. This paper was with the authors 1 week for 1 revision. Published online in Articles in Advance June 20, 2008., 1. Introduction In this paper, we investigate deterministic fluid approximations for overloaded qeueing systems having multiple customer classes and multiple service pools, each with many servers. Each customer class has [...]

We consider information sharing in a decentralized supply chain where one manufacturer supplies to multiple retailers competing in price. Each retailer has some private information about the uncertain demand function which he may choose to disclose to the manufacturer. The manufacturer then sets a wholesale price based on the information received. The information exchange is said to be confidential if the manufacturer keeps the received information to herself, or nonconfidential if she discloses the information to some or all other retailers. Without confidentiality, information sharing is not possible because it benefits the manufacturer but hurts the retailers. With confidentiality, all parties have incentive to engage in information sharing if retail competition is intense. Under confidentiality, the retailers infer the shared information from the wholesale price and this gives rise to a signaling effect that makes the manufacturer's demand more price elastic, resulting in a lower equilibrium wholesale price and a higher supply chain profit. When all retailers share their information confidentially, they will truthfully report the information and the supply chain profit will achieve its maximum in equilibrium. Key words: information sharing; confidentiality; signaling; supply chain coordination; truth telling History: Accepted by Gerard P. Cachon, operations and supply chain management; received November 21, 2005. This paper was with the authors 1 year and 4 months for 3 revisions. Published online in Articles in Advance May 19, 2008., 1. Introduction This paper is concerned with vertical information sharing in a supply chain consisting of one manufacturer and two or more competing retailers. Each retailer has some private information [...]

In this paper, we study a firm that faces demand from two sources: demand for new items and demand to replace failed items under warranty. We model this setting as a multiperiod single-product inventory problem where the demands for new items in different periods are independent and the demands for replacing failed items depend on the number and ages of the items under warranty. We consider backlogging and emergency supply cases, and study both discounted cost and average cost criteria. We prove the optimality of the ω-dependent base-stock ordering policy where the base-stock level is a function of ω, the vector representing the number of items at different ages currently under warranty. For the special case where the demand for new products is identically distributed, we prove the optimality of a stationary ω-dependent base stock policy for the finite-horizon discounted and the infinite-horizon discounted and average cost cases. In our computational study, we find that an optimal ω-dependent policy can lead to 69% average improvement in expected costs when compared to a policy that neglects demands from items under warranty. Key words: warranty; inventory; stochastic demand; information History: Accepted by Paul H. Zipkin, operations and supply chain management; received September 14, 2005. This paper was with the authors 1 year for 2 revisions. Published online in Articles in Advance June 10, 2008., 1. Introduction As firms attempt to optimize their end-to-end supply chains, their focus is turning toward the closed-loop nature of supply chain operations (see Guide and Wassenhove 2003, Dekker et [...]

This paper was motivated by an observation in an international airport with regard to allocation of resources for check-in counters. In an exclusive check-in counter system, each flight has a dedicated number of counters that will be open until at least a half-hour before the scheduled departure of that flight. Currently, in many of the airports around the world, the decision to open or close check-in counters is done on an ad hoc basis by human schedulers. In doing so, the schedulers are almost always forced to perform a balancing act in meeting the quality of service stipulated by the airport authority vis-a-vis the optimal allocation of the resources to the counters. There appear to be very few academic and application papers in counter management, and most of those that have looked into this problem have resorted to simulation to study the queue characteristics. Ours is the first paper to show that for a specific flight, this complicated problem is amenable to analytical treatment. We first propose a multicounter queueing model with a special type of arrival process reflecting reality from the population of passengers booked for the flight. Most importantly, we derive the time-dependent operating characteristics to the queueing process under a specified time-window constraint. Then a stochastic dynamic programming model is formulated to determine the optimal numbers of counters to open over the time window specified. A numerical example is provided to illustrate the model solution and gain managerial insights. Key words: queues; transient results; dynamic programming; applications; transportation; scheduling History: Accepted by Michael Fu, stochastic models and simulation; received September 20, 2006. This paper was with the authors 2 1/2. months for 2 revisions. Published online in Articles in Advance May 14, 2008., 1. Introduction Globally, the recent years have witnessed a dramatic surge in demand for air transportation. Notwithstanding the post-9/11 impact, factors like globalization and the measures taken by governments in [...]

In this paper, we present a finite sample analysis of the sample minimum-variance frontier under frontier under the assumption that the returns are independent and multivariate normally distributed. We show that the sample minimum-variance frontier is a highly biased estimator of the population frontier, and we propose an improved estimator of the population frontier. In addition, we provide the exact distribution of the out-of-sample mean and variance of sample minimum-variance portfolios. This allows us to understand the impact of estimation error on the performance of in-sample optimal portfolios. Key words: minimum-variance frontier; efficiency set constants; finite sample distribution History: Accepted by David A. Hsieh, finance; received April 4, 2007. This paper was with the authors 2 weeks for 1 revision. Published online in Articles in Advance May 22, 2008., 1. Introduction The minimum-variance frontier plays a central role in much of finance. For example, it is the cornerstone of modern portfolio theory and many asset pricing models. In addition, [...]

This paper is an update of a paper that five of us published in 1992. The areas of multiple criteria decision making (MCDM) and multiattribute utility theory (MAUT) continue to [...]

From a large array of economic and financial data series, this paper identifies three fundamental risk dimensions underlying an economy: inflation, real output growth, and financial market volatility. Furthermore, through [...]

Using a data set including album sales, Internet penetration, and various demographic measures for 99 American cities over the period 1998-2003, this paper empirically examines the extent to which file sharing has caused the U.S. decline in sound-recording sales over that period. Also examined is the impact of the Internet on entertainment activities so as to help cleanse the Internet penetration coefficient of that impact. The conclusion from this analysis is that file sharing appears to have caused the entire decline in record sales and appears to have vitiated what otherwise would have been growth in the industry. Key words: file sharing; peer-to-peer; copying; Internet; sound recordings; television; radio, 1. Introduction File sharing is merely the most recent example in a long line of technologies (e.g., photocopying, audio, and video taping) that have lowered the cost of unauthorized copying [...]

In this paper, we study a decentralized assembly system consisting of a single assembler who buys complementary components from independent suppliers under two contracting schemes: push and pull. In both schemes, the component suppliers are allowed to freely form coalitions (or alliances) among themselves to better coordinate their pricing or production decisions. We show that the sole driver of the inefficiency in a push system, which is due to horizontal decentralization of suppliers, is the number of alliances that were formed. Specifically, it is shown that in a push system, the assembler's profit, the total profit of all suppliers and the consumers' surplus are all decreasing in the number of coalitions, and are thus maximized when the grand coalition is formed. We further carry out a stability analysis of coalition structures to verify to what extent suppliers can reduce or eliminate the inefficiency due to their decentralization by forming alliances. We show that in a push system with more than two suppliers and a power demand distribution, myopic suppliers would act independently, resulting with a least efficient channel, which makes all channel members, as well as the end consumers, worse off. On the other hand, we prove that farsighted suppliers would form the grand coalition and thus be able to completely eliminate the inefficiency stemming from their decentralization. Finally, it is shown that, in contrast to a push system, in a pull system the suppliers can easily coordinate their production quantities to eliminate the inefficiency due to their decentralization. Key words: alliance formation; newsvendor model; stable coalitions; push and pull models, 1. Introduction In this paper, we analyze a single-period decentralized assembly system with a single final product under two contracting schemes: push and pull. The terms 'push' and 'pull' are [...]

In a recent paper, Mishra and Raghunathan (Mishra, B. K., S. Raghunathan. 2004. Retailer- vs. vendor-managed inventory and brand competition. Management Sci. 50(4) 445-457) claimed that retailers prefer vendor-managed inventory (VMI) because it restores competition among manufacturers and encourages them to maintain a higher stock of their own brand under VMI than would be maintained under retailer-managed inventory (RMI). This paper shows that these results do not hold in general: each manufacturer's stocking level may be higher under RMI than under VMI and the retailer may lose by adopting VMI depending on the profit margin of the retailer relative to that of the manufacturers, the magnitude of the holding costs, and the intensity of brand competition. Numerical examples show that the effect of brand competition on the system is not so significant and the transfer of holding cost to the vendor is the key incentive for the retailer's adoption of VMI. Key words: retailing; supply chain management; product substitution; inventory management; competition, 1. Introduction Recently, Mishra and Raghunathan (2004; M & R for short) claimed that, under vendor-managed inventory (VMI), the retailer benefits from higher inventory availability that arises from restoration of [...]

We investigate the benefits of migrating from a call center, where all agents are pooled and customers are treated indifferently by any agent, toward a call center where customers are grouped into clusters with dedicated teams of agents. Each cluster is referred to as a portfolio. Customers of the same portfolio are always served by an agent of the corresponding team. There is no specialization involved in this organization in the sense that all customer portfolios as well as all agent teams have (statistically) identical behaviors. The reason for moving to this organization is that dealing with teams of limited size allows a much better workforce management than the situation usually encountered in large call centers. The purpose of this paper is to examine how the benefits of moving to this new organization can outweigh the drawbacks. The drawbacks come from the fact that there is less of a pooling effect in the new organization than in the original one. The benefits come from the better human resource management that results in a higher efficiency of the agents, both in terms of speed and quality of the answers they provide to customers. Our analysis is supported by the use of some simple queueing models and provides some interesting insights. In particular, it appears that for some reasonable ranges of parameters, the new organization can outperform the original organization. We then extend the analysis to the case where, in addition to the identified customer portfolios, there is an additional flow of calls called out-portfolio flow. It is shown that this feature makes the new organization even more efficient. Key words: call center management; quality of service; pooling; human resource management; customer portfolio management; team-based organization; queueing models, 1. Introduction Recently, the number of call centers has been increasing drastically. Call centers are a means of customer relationship management, and their role is growing. A call center is [...]

This paper considers a call center outsourcing contract analysis and choice problem faced by a contractor and a service provider. The service provider receives an uncertain call volume over multiple periods and is considering outsourcing all or part of these calls to a contractor. Each call brings in a fixed revenue to the service provider. Answering calls requires having service capacity; thus implicit in the outsourcing decision is a capacity decision. Insufficient capacity implies that calls cannot be answered, which in turn means there will be a revenue loss. Faced with a choice between a volume-based and a capacity-based contract offered by a contractor that has pricing power, the service provider determines optimal capacity levels. The optimal price and capacity of the contractor together with the optimal capacity of the service provider determine optimal profits of each party under the two contracts being considered. This paper characterizes optimal capacity levels and partially characterizes optimal pricing decisions under each contract. The impact of demand variability and the economic parameters on contract choice are explored through numerical examples. It is shown that no contract type is universally preferred and that operating environments as well as cost-revenue structures have an important effect. Key words: call center; outsourcing; subcontracting; contract choice; capacity investment; pricing, 1. Introduction A growing number of companies outsource their call center operations. While for some companies outsourcing the entire call center operation constitutes the best option, many are hesitant to [...]

This paper characterizes the conditions for strong risk aversion and second-order stochastic dominance for cumulative prospect theory. Strong risk aversion implies a convex weighting function for gains and a concave one for losses. It does not necessarily imply a concave utility function. The latter does follow if the weighting functions are continuous. By investigating the exact relationship between loss aversion and strong risk aversion, a natural index for the degree of loss aversion is derived. Key words: cumulative prospect theory; loss aversion; risk aversion; second-order stochastic dominance; decision analysis theory; risk, 1. Introduction Cumulative prospect theory (CPT) has emerged as one of the most prominent alternatives to expected utility (EU). It is widely used in empirical research and, building on prospect [...]

In this paper, we revisit and clarify the celebrated machine maintenance and sale age model of Kamien and Schwartz (KS) involving a machine subject to failure. KS formulate and solve the problem as a deterministic optimal control problem with the probability of the machine failure as the state variable. Thus, they obtain deterministic optimal maintenance and sale date. We study two underlying stochastic models with known and random machine modes, and clarify the relationship between the resulting value functions to that of KS. In particular, our maintenance and sale date decisions, when the machine is in operation, are precisely the ones obtained from the deterministic solution of KS. We explain why that is so. Moreover, we provide a sufficient condition for an optimal maintenance and sale date policy that is missing in KS. We describe many applications of the KS model in areas other than that of machine maintenance. We conclude the paper with extensions of the KS problem that are stochastic control problems not easily solvable or not at all solvable as deterministic problems. Key words: optimal control; stochastic control; dynamic programming; variational inequality; maintenance and replacement, 1. Introduction Over 35 years ago, Kamien and Schwartz (1971a) wrote a seminal paper on optimal maintenance and sale age of a machine subject to failure. In their model, the [...]

This paper studies a procurement problem with one buyer and multiple potential suppliers who hold private information about their own production costs. Both the purchase quantity and the price need to be determined. An optimal procurement strategy for the buyer requires the buyer to first design a supply contract that specifies a payment for each possible purchase quantity and then invites the suppliers to bid for this contract. The auction can be conducted in many formats such as the English auction, the Dutch auction, the first-priced, sealed-bid auction, and the Vickrey auction. The winner is the supplier with the highest bid, and is given the decision right for the quantity produced and delivered. Applying this theory to a newsvendor model with supply-side competition, this paper establishes a connection between the above optimal procurement strategy and a common practice in the retail industry, namely, the use of slotting allowances and vendor-managed inventory. Also discussed in the newsvendor context are the role of well-known supply contracts such as returns contracts and revenue-sharing contracts in procurement auctions, the scenarios where the buyer and suppliers may possess asymmetric information about the demand distribution, and how the cost of supply-demand mismatch is affected by supply-side competition. Finally, this paper compares the optimal procurement strategy with a simpler but suboptimal strategy where the buyer first determines a purchase quantity and then seeks the lowest-cost supplier for the quantity in an auction. Key words: procurement strategies; decision rights; newsvendor model; auctions; competitive bidding; slotting allowances, 1. Introduction Mathematical models in operations management addressing procurement decisions (i.e., when and how much to buy) often make the simplistic assumption that the prices for the items to be [...]

This paper studies how judicious resource allocation in networks mitigates risk. Theory is presented for general utility functions and mean-variance formulations and is illustrated with networks featuring resource diversification, flexibility (e.g., inventory substitution), and sharing (commonality). In contrast to single-resource settings, risk-averse newsvendors may invest more in networks than risk-neutral newsvendors: some resources and even total spending may exceed risk-neutral levels. With normally distributed demand, risk-averse newsvendors change resource levels roughly proportionally to demand variance, while risk-neutral agents adjust only proportionally to standard deviation. Two effects explain this operational hedge and suggest rules of thumb for strategic placement of safety capacity and inventory in networks: (1) Risk pooling suggests rebalancing capacity toward inexpensive resources that serve lower-profit variance markets. This highlights the role of profit variance (instead of demand variance) in risk-averse network investment. (2) Ex post revenue maximization suggests rebalancing capacity toward substitutable flexible but away from shared capacity when markets differ in profitability. Capacity imbalance and allocation flexibility thus mitigate profit risk and truly are operational hedges. Key words: risk aversion; mean-variance; capacity; inventory; investment; balance; real options; network design, 1. Introduction This paper studies how resource allocation in networks can mitigate risk exposure. It presents theory and insight on how risk attitude and network configuration drive the strategic placement [...]

Geographically dispersed sellers in electronic reverse marketplaces such as those hosted by market-makers like Ariba are uncertain about the number of competitors they face in any given market session. We refer to this uncertainty about the number of competitors as market-structure uncertainty. Over the course of several market sessions sellers learn about the competitive nature of the marketplace. How they learn to reduce the market-structure uncertainty depends on the market-transparency scheme, or the revelation policy adopted. A revelation policy determines the extent to which information--the number of sellers in a session, their bidding patterns, etc.--is revealed to sellers. Because these policies control what sellers learn and how they bid in future sessions, they determine buyer surplus. Possibly because market-structure uncertainty is more prevalent in information technology-enabled marketplaces than traditional ones, prior work has not addressed the impact of revelation policies on this type of uncertainty. Currently, there is little guidance available to buyers in choosing the appropriate revelation policy. To address this information-technology-enabled problem, we use game theory to compare the buyer surplus generated under a set of revelation policies commonly used in electronic reverse marketplaces. We demonstrate that the policy that generates the least amount of market-structure uncertainty for the sellers always maximizes buyer surplus. We further investigate to provide intuition regarding how bidders' reactions to overcome uncertainty differs with the nature of uncertainty, and how those reactions impact buyer surplus. Key words: market transparency; electronic markets; information systems; IT policy and management; economics of IS, 1. Introduction Ariba, (1) a B2B market-maker, convenes electronic reverse auctions (i.e., market sessions) at the request of buyers. Among other attributes, buyers determine the market-transparency scheme, or information-revelation policy, [...]

Any buyer that depends on suppliers for the delivery of a service or the production of a make-to-order component should pay close attention to the suppliers' service or delivery lead times. This paper studies a queueing model in which two strategic servers choose their capacities/processing rates and faster service is costly. The buyer allocates demand to the servers based on their performance; the faster a server works, the more demand the server is allocated. The buyer's objective is to minimize the average lead time received from the servers. There are two important attributes to consider in the design of an allocation policy: the degree to which the allocation policy effectively utilizes the servers' capacities and the strength of the incentives the allocation policy provides for the servers to work quickly. Previous research suggests that there exists a trade-off between efficiency and incentives, i.e., in the choice between two allocation policies a buyer may prefer the less efficient one because it provides stronger incentives. We find considerable variation in the performance of allocation policies: Some intuitively reasonable policies generate essentially no competition among servers to work quickly, whereas others generate too much competition, thereby causing some servers to refuse to work with the buyer. Nevertheless, the trade-off between efficiency and incentives need not exist: It is possible to design an allocation policy that is efficient and also induces the servers to work quickly. We conclude that performance-based allocation can be an effective procurement strategy for a buyer as long as the buyer explicitly accounts for the servers' strategic behavior. Key words: game theory; joining behavior; Nash equilibrium; procurement; sourcing; supplier management History: Accepted by Wallace J. Hopp, stochastic models and simulation; received February 1, 2005. This paper was with the authors 8 months for 2 revisions., Fast service is clearly important. Less obvious is how to go about obtaining fast service from suppliers or service providers. One technique is to make servers compete by allocating business [...]

This paper studies the impact of competition on a firm's choice of technology (product-flexible or product-dedicated) and capacity investment decisions. Specifically, we model two firms competing with each other in two markets characterized by price-dependent and uncertain demand. The firms make three decisions in the following sequence: choice of technology (technology game), capacity investment (capacity game), and production quantities (production game). The technology and capacity games occur while the demand curve is still uncertain, and the production game is postponed until after the demand curve is revealed. We develop best-response functions for each firm in the technology game and compare how a monopolist and a duopolist respond to a given flexibility premium. We show that the firms may respond to competition by adopting a technology which is the same as or different from what the competitor adopts. We conclude that contrary to popular belief, flexibility is not always the best response to competition--flexible and dedicated technologies may coexist in equilibrium. We demonstrate that as the difference between the two market sizes increases, a duopolist is willing to pay less for flexible technology, whereas the decision of a monopolist is not affected. Further, we find that a firm that invests in flexibility benefits from a low correlation between demands for two products, but the extent of this benefit differs depending on the competitor's technology choice. Our results indicate that higher demand substitution may or may not promote the adoption of flexibility under competition, whereas it always facilitates the adoption of flexibility without competition. Finally, we show that contrary to intuition, as the competitor's cost of capacity increases, the premium a flexible firm is willing to pay for flexibility decreases. Key words: technology; flexible capacity; uncertainty; equilibrium; competition, 1. Introduction Flexible manufacturing systems (FMS) allow a firm to cope better with demand uncertainty when manufacturing several products in the same facility by cutting production of goods for which [...]

This paper proposes an extreme value approach to estimating interest-rate volatility, and shows that during the extreme movements of the U.S. Treasury market the volatility of interest-rate changes is underestimated by the standard approach that uses the thin-tailed normal distribution. The empirical results indicate that (1) the volatility of maximal and minimal changes in interest rates declines as time-to-maturity rises, yielding a downward-sloping volatility curve for the extremes; (2) the minimal changes are more volatile than the maximal changes for all data sets and for all asymptotic distributions used; (3) the minimal changes in Treasury yields have fatter tails than the maximal changes; and (4) for both the maxima and minima, the extreme changes in short-term rates have thicker tails than the extreme changes in long-term rates. This paper extends the standard option-pricing models with lognormal forward rates to accommodate significant kurtosis observed in the interest-rate data. This paper introduces a closed-form option-pricing model based on the generalized extreme value distribution that successfully removes the well-known pricing bias of the lognormal distribution. Key words: extreme value distributions; interest-rate options; term structure of interest rates; volatility; skewed fat-tailed distributions, 1. Introduction The default-free short-term interest rate driving the changes in the entire term structure is fundamental to the classical approach to pricing fixed-income securities and derivatives. Both equilibrium and [...]

This paper presents new evidence regarding a firm's probability for survival, based on the network structure of the firm's managers. We found that start-ups that have larger informal communication networks increased their chance to survive external shock. Original data have been collected from Israeli software start-ups during the dot-com economic growth. About eight years later, we added information about their ability to survive the burst of the dot-com bubble. From a theoretical point of view, this paper highlights the power of the classic social networks approach in explaining organizational performance. From a practical point of view, these findings offer some guidelines for managers of start-ups. Our results show that the size of informal interfirm networks really matters. Key words: organizational studies; strategy; communication networks; start-ups, Introduction--Social Embeddedness and Organizational Performance There is conflicting evidence about the benefits of network ties and embeddedness on firm performance. Positive effects of linkages have been observed by Miner et [...]