The effect of risk aversion on manufacturer promotion in a two-stage supply chain

We consider a supply chain system with a risk-neutral manufacturer as the leader and a risk-averse retailer as the follower in the environment with uncertain demand. At the beginning of the game, the manufacturer makes investment on promotion effort and then the retailer decides his ordering quantity before demand realization. The analysis of equilibrium strategies of this Stackelberg game indicates some characteristics which are different from promotion strategies with risk neutral agents. Firstly, there exists an upper bound for the retailer’s target profit , otherwise the equilibrium strategy is unavailable. Secondly, the retailer’s risk aversion has direct influence on the manufacturer’s promotion investment. In other words, the manufacturer will increase his promotional effort when the retailer has an appropriate degree of risk aversion and cuts down that for a highly risk-averse one. Thirdly, although conventional wisdom suggests that risk-averse retailer definitely reduce his ordering quantity, we find that manufacturer’s promotion can effectively prevent the risk-averse retailer from downsizing inventory which is decided by the joint power of the promotion effort and the variable pair . Key word: Risk aversion; Promotion effort; Newsvendor