Managing Supply Chain Backorders under Vendor Managed Inventory: A Principal-Agent Approach and Empirical Analysis

This paper examines the relationship between distributor backorder performance and its inventory levels under Vendor Managed Inventory (VMI) in a supply chain that consists of distributors and manufacturers. We construct a principal-agent model to show that distributors' inventory managed by manufacturers can be used to induce distributor efforts, which are unobservable to the manufacturers, in converting lost sales into backorders in the case of stockouts. We use EDI transaction data collected from the electronic component and truck part industry to test our results from the analytical modeling. The empirical results provide strong supports for the proposition that there is a strong adverse relationship between the inventory level and backorder conversion rate, suggesting the manufacturer could use a lower distributor inventory as an incentive for the distributors to convert more lost sales into backorders.