When customers anticipate liquidation sales: managing operations under financial distress
Journal
Manufacturing & Service Operations Management
Subject
Management Science and Operations
Publishing details
Authors / Editors
Birge JR;Parker R P;Wu M X;Yang SA
Biographies
Publication Year
2017
Abstract
The presence of strategic customers may force an already financially distressed firm into a death spiral: Sensing the firm's financial difficulty, customers may wait strategically for deep discounts in liquidation sales. In turn, such waiting lowers the firm's pro fitability and increases the firm's bankruptcy risk. Using a two-period model to capture these dynamics, this paper identi fies customers' strategic waiting behavior as a source of a firm's cost of financial distress. We also find that customers' anticipation of bankruptcy can be self-ful filling: When customers anticipate a high bankruptcy probability, they prefer to delay their purchases, making the firm more likely to go bankrupt than when customers anticipate a low probability of bankruptcy. Such behavior has important operational and financial implications. First, the firm acts more conservatively when either facing more severe financial distress or a large share of strategic customers. As its financial situation deteriorates, the firm lowers inventory alone when financial distress is mild or only a small share of customers are strategic and lowers both inventory and price in the presence of severe financial distress and a large fraction of strategic customers. Under optimal price and inventory decisions, strategic waiting accounts for a large part of the firm's total cost of fi nancial distress, although a larger proportion of strategic customers may result in a lower probability of bankruptcy. In addition to inventory reduction and (immediate) price discount, we find that a deferred discount, in the form of rebates and/or store credits for future purchases, can act as an effective mechanism to mitigate strategic waiting. As a contingent price reduction, deferred discounts align the interests of customers and the fi rm and are most effective when the fraction of strategic customers is high and the firm's financial distress is at a medium level.
Keywords
Financial distress; Liquidation sale; Strategic customers; Inventory; Pricing; Deferred discount; Rebate; Store credit
Available on ECCH
No
