On Coordinating a Loss-Averse OEM Supply Chain with Random Supply and Demand

Abstract

This paper establishes a Stackelberg game between a risk-neutral OEM and a loss-averse CM, based on a piecewise-linear utility function and investigates an OEM supply chain consisting of a loss-averse CM and a risk-neutral OEM, with random supply and random demand. The result shows that the loss-averse CM’s unique optimal order quantity is always less than the risk-neutral CM’s under decentralized decision making. Loss aversion can also affect the order quantity. When an OEM is more loss-averse, the order quantity gets smaller. The OEM supply chain can be coordinated when the order quantity is increased through the CM penalizing the OEM for shortages and sharing a proportion of revenue with the OEM.