Group for Research in Decision Analysis

Nash Bargaining over Allocations in Inventory Pooling Contracts

Yigal Gerchak Tel Aviv University, Israel

When facing uncertain demand, several firms may consider pooling their inventories leading to the emergence of two key contractual issues. How much should each produce or purchase for inventory purposes? How should inventory be allocated when shortages occur to some of the firms? Previously, if the allocations issue was considered, it was undertaken through evaluation of the consequences of an arbitrary priority scheme. We consider both these issues within a Nash Bargaining Solution (NBS) cooperative framework. The firms may not be risk neutral, hence a Non-Transferable Utility (NTU) bargaining game is defined. Thus the physical pooling mechanism itself must benefit the firms, even without any monetary transfers. The firms. may be asymmetric in the sense of having different unit production costs and unit revenues. Our assumption with respect to shortage allocation is that a firm not suffering from a shortfall with respect to their entitlement, will not be affected by any of the other firms’ shortages. For risk neutral firms, the NBS is shown to award absolute priority on all inventory produced to the firm with highest ratio of unit revenue to unit production cost. Nevertheless, the arrangement is beneficial also for other firms contributing to the total production. We provide examples of Uniform and Bernoulli demand distributions, for which the problem can be solved analytically. For firms with constant absolute risk aversion (CARA), the resulting priority may not be absolute. Analytically solvable examples allow additional insights, e.g. that higher risk aversion can, for some problem parameters, cause an increase in the sum of quantities produced, which is not the case in a single newsvendor setting.