Supplier Competition: Theory vs. Experiment

We use laboratory experiments to investigate the decisions made by suppliers when they compete for the demand share of a buyer in an outsourcing setup. More specifically, we consider a supply chain in which a single buyer outsources the manufacture of a product to suppliers not on the basis of price, but rather on service. Three different criteria on which suppliers compete are evaluated: 1) a guaranteed specific inventory fill-rate, 2) guaranteed level of base-stock, and 3) a parameter optimizing the supply chain in the buyer's favor. Our results show that in most cases, suppliers' decisions are significantly different than the Nash equilibrium, meaning that they do not maximize profit. To explain this deviation of experimental results from what theory predicts, we examine the impact of three behavioral factors: (a) loss aversion, (b) rival chasing, and (c) the gamesmanship behavior which is defined as the suppliers' tendency to beat the competition instead of maximizing the profit.