NORTHWESTERN UNIVERSITY SUPPLY CHAIN MANAGEMENT IN THE PRESENCE OF STRATEGIC CONSUMERS AND CONSUMPTION EXTERNALITIES A DISSERTATION SUBMITTED TO THE GRADUATE SCHOOL IN PARTIAL FULFILLMENT OF THE REQUIREMENTS for the degree DOCTOR OF PHILOSOPHY Field of Industrial Engineering and Management Sciences By KENAN AR ˙ IFO ˘ GLU EVANSTON, ILLINOIS August 2012 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent on the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. All rights reserved. This edition of the work is protected against unauthorized copying under Title 17, United States Code. ProQuest LLC. 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, MI 48106 - 1346 UMI 3527503 Copyright 2012 by ProQuest LLC. UMI Number: 3527503 2 c  Copyright by KENAN AR ˙ IFO ˘ GLU 2012 All Rights Reserved 3 Abstract SUPPLY CHAIN MANAGEMENT IN THE PRESENCE OF STRATEGIC CONSUMERS AND CONSUMPTION EXTERNALITIES KENAN AR ˙ IFO ˘ GLU In this dissertation, I study the management of supply chains in which consumers’ utilities from the product depend on the total consumption (consumption externalities) and all parties involved, consumers as well, maximize their own well-being (strategic consumers). I consider two practical motivations: vaccine for seasonal influenza (flu) epidemic and high-fashion luxury goods. In Chapter 2, I study the impact of yield uncertainty (supply side) and self-interested consumers (demand side) on the inefficiency in the influenza vaccine supply chain. Previous economic studies, focusing on demand side, find that the equilibrium demand is always less than the socially optimal demand since self-interested individuals do not internalize the social benefit of protecting others via reduced infectiousness (positive externality). In contrast, I show that the equilibrium demand can be greater than the socially optimal demand after accounting for the limited supply due to yield uncertainty and manufacturer’s incentives. The main driver for this result is a second (negative) externality: self- interested individuals ignore that vaccinating people with high infection costs is more beneficial for the society when supply is limited. I show that the extent of the negative externality can be reduced through more efficient and less uncertain allocation mechanisms. In order to investigate the relative effectiveness of government interventions on supply and demand sides under various demand and supply 4 characteristics, I construct two partially centralized scenarios, where the social planner (government) intervenes either on the demand side or the supply side but not both, and conduct an extensive numerical analysis. In Chapter 3, I develop a mechanism which coordinates a supply chain with consumption exter- nalities and a profit-maximizing manufacturer having uncertain production process in the presence of rational consumers. This mechanism includes tax/subsidy payments on the demand side (individual con- sumers) and a transfer payment on the supply side (manufacturer). I show that, under the mechanism, the manufacturer is ex ante better off; moreover, expected total utility of all individuals are higher. I also show that the mechanism allows arbitrary division of ex ante total social welfare between individuals and the manufacturer. Chapter 4 develops an analytical model to study the impact of snobbish (exclusivity-seeking) con- sumer behavior on a firm’s price and quantity decisions. I consider a profit-maximizing monopoly firm selling a product over two periods to two segments of consumers (with high and low valuation of the product), who are forward-looking and snobbish, i.e., their valuation of the product decreases as more people in the population consume it. This modeling framework enables me to explain the heterogeneity in pricing of snob appeal products observed in practice. Specifically, I find that markdown pricing is op- timal when the fraction of high-value consumers is small whereas uniform pricing is optimal when this fraction is large. Thus, snobbish consumer behavior provides another motivation for markdown pricing. When selling to snobbish consumers, inter-temporal price discrimination increases product exclusivity and hence consumers’ willingness to pay, in addition to the usual effect of attracting consumers with different valuations. Similar to normal products, I find that advance purchase discounts are optimal only when consumers do not know their true valuations in the first period. However, I show that snobbish consumer behavior coupled with uncertain valuations may lead to discounts in advance. I use this mod- eling framework to formally distinguish between scarcity and exclusivity, where the former is defined with respect to the demand whereas the latter is defined with respect to the entire population. I find that 5 snobbish consumer behavior leads to scarcity, but not necessarily to exclusivity, i.e., the product may be exclusive even when consumers are not snobbish. Finally, contrary to intuition, I find that the product may become more exclusive when the price is marked down and hence price markdowns need not always be associated with excess inventory when selling to snobbish consumers. 6 Acknowledgements This dissertation would not have been possible without the guidance of my committee members, help from friends, and support from my family. I would like to express my deepest gratitude to my principal advisor, Prof. Seyed Iravani, for his guidance, caring, and providing me with an excellent free research atmosphere. I am indebted to my second advisor, Prof. Sarang Deo. I thank him for many stimulating academic discussions, his dedicated advising, his work ethic, and his incredible involvement, support and encouragement. I learned a lot from both of my advisors. I am very grateful to Prof. Izak Duenyas for his guidance and support during my research assist- antship at the University of Michigan. He was a great resource for me. I enjoyed working with him and engaging in academic discussions. I thank my committee member Prof. Diego Klabjan for his thought-provoking questions and suggestions. I thank Prof. Martin Larivieri for always being there to discuss research problems. His suggestions greatly improved this dissertation. I thank Prof. Barıs¸ Ata for his mentorship. I have been very fortunate to know many people during my doctoral study at Northwestern Univer- sity. I am thankful to all of my professors, classmates, and officemates. My special thanks go to Linlin, Luis, Mustafa, Neda, and Yan. I have benefited a lot from my conversations with them. I also would like to thank Ahmet, Betul, Can, G ¨ okhan, G ¨ urkan, Kezban, Koray, Muzaffer, and Yasin. They were a constant source of encouragement and support; it would have been very boring without their companionship. 7 Last, but definitely not the least, I am immensely grateful to my family, especially to my parents. It was their unconditional love, care, and encouragement which made this dissertation possible. Without their support, I do not think that I could overcome the difficulties during these years. 8 Dedication To my parents, Ali and Radet Arifo ˘ glu, who made all of this possible, for their love and continuous support. 9 Contents Abstract 3 Acknowledgements 6 Dedication 8 List of Tables 11 List of Figures 12 Chapter 1. Introduction 14 Chapter 2. Consumption Externality and Yield Uncertainty in the Influenza Vaccine Supply Chain: Interventions in Demand and Supply Sides 19 2.1. Introduction 19 2.2. Literature Review 22 2.3. Model and Assumptions 24 2.4. Equilibrium in the Decentralized System 28 2.5. Optimal Solution of the Centralized System 33 2.6. Government Interventions 39 2.7. Deterministic Yield 43 2.8. Numerical Study 44 2.9. Conclusion and Future Research 50 2.A. Appendix for Chapter 2 51 [...]... main findings and discuss about the ideas for future research in Chapter 5 19 CHAPTER 2 Consumption Externality and Yield Uncertainty in the In uenza Vaccine Supply Chain: Interventions in Demand and Supply Sides 2.1 Introduction Unlike pediatric vaccines, supply chain for the in uenza (flu) vaccine in the U.S is highly decentralized Profit maximizing firms decide the production quantity and bring the. .. epidemic and luxury goods In Chapter 2, we study the in uenza (flu) vaccine supply chain in the USA The in uenza vaccine in the USA is produced by private companies through a complex and unreliable production process and consumers make their vaccination decisions in a rational and self-interested way [Pauly, 2005; Vietri et al., 2008] The supply chain of vaccines, especially that of in uenza vaccine, has... debate, in Chapter 2, we also analyze the relative effectiveness of government interventions in only one (demand or supply) side of the supply chain In Chapter 3, motivated by flu vaccine supply chain, we design a mechanism which eliminates the entire inefficiency in a supply chain with consumption externalities and a profit-maximizing manufacturer having uncertain production yield This mechanism aligns consumers ... ignoring strategic consumer behavior and consumption externalities cannot accurately represent the supply chain of certain products The solution of such a model may exacerbate 16 the total supply chain inefficiency Thus, in this research, we study the supply chains with strategic consumer behavior and consumption externalities Our research is particularly motivated by the vaccine for seasonal in uenza... allocation of facilities to market locations, inventory control, coordination and information sharing between the parties in a supply chain, etc Chopra and Meindl [2004, pg 31] consider “understanding the customer” as an essential part of SCM The way consumers think and their motivations for consumption affect both marketing and supply chain strategies (i.e., operations, distribution and service) of a firm... (2.12) The first term on the RHS of (2.11) is the average utility of being healthy, the second term is the average utility loss of the individual due to searching, the third term represents the average cost from receiving the vaccine, the fourth term is the average utility loss of individual due to infection if she does not search for the vaccine, and the last term is the average utility loss of individual... vaccine to the market while individuals decide whether or not to get vaccinated in a rational and self-interested manner based on the availability of the vaccine, severity of the infection, and vaccination costs [Vietri et al., 2008] The role of the government and its agencies such as the Center for Diseases Control and Prevention (CDC) is limited to deciding the vaccine composition and recommending... disutility of its individuals First, given the design of priority groups, the manufacturer decides the production quantity and incurs the related production cost A random fraction of this production quantity is realized and brought to the market The supply received at the beginning of the flu season is first allocated to the group with higher infection disutility, and the remaining supply, if any, is then... the existence of a marginal individual who is indifferent between searching and not searching such that all individuals with infection disutility higher than that of marginal individual search for the vaccine We define δ E (β, Qr ) as the infection disutility of the marginal individual in equilibrium In what follows, we suppress the arguments ¯ of δ E (β, Qr ) to improve readability The vaccine demand... Supply chain management (SCM) is the integration of key business processes across the supply chain for the purpose of creating value for customers and stakeholders [Cooper et al., 1997] In the last 30 years, SCM has gotten a lot of scholarly attention Researchers in operations management /research studied various aspects of SCM, i.e., number and location of facilities in a supply chain, amount of capacity . Reserved 3 Abstract SUPPLY CHAIN MANAGEMENT IN THE PRESENCE OF STRATEGIC CONSUMERS AND CONSUMPTION EXTERNALITIES KENAN AR ˙ IFO ˘ GLU In this dissertation, I study the management of supply chains in which consumers . UNIVERSITY SUPPLY CHAIN MANAGEMENT IN THE PRESENCE OF STRATEGIC CONSUMERS AND CONSUMPTION EXTERNALITIES A DISSERTATION SUBMITTED TO THE GRADUATE SCHOOL IN PARTIAL FULFILLMENT OF THE REQUIREMENTS for the. main findings and discuss about the ideas for future research in Chapter 5. 19 CHAPTER 2 Consumption Externality and Yield Uncertainty in the In uenza Vaccine Supply Chain: Interventions in Demand