When customers anticipate liquidation sales: managing operations under financial distress

Birge, J R, Parker, R P, Wu, M X and Yang, S A (2017) When customers anticipate liquidation sales: managing operations under financial distress. Manufacturing and Service Operations Management, 19 (4). pp. 657-673. ISSN 1523-4614 OPEN ACCESS


The presence of strategic customers may force an already financially distressed firm into a death spiral:
Sensing the firm's financial difficulty, customers may wait strategically for deep discounts in liquidation
sales. In turn, such waiting lowers the firm's profitability and increases the firm's bankruptcy risk. Using a two-period model to capture these dynamics, this paper identifies customers' strategic waiting behavior
as a source of a firm's cost of financial distress. We also find that customers' anticipation of bankruptcy
can be self-fulfilling: When customers anticipate a high bankruptcy probability, they prefer to delay their
purchases, making the firm more likely to go bankrupt than when customers anticipate a low probability of
bankruptcy. Such behavior has important operational and financial implications. First, the firm acts more
conservatively when either facing more severe financial distress or a large share of strategic customers. As
its financial situation deteriorates, the firm lowers inventory alone when financial distress is mild or only a
small share of customers are strategic and lowers both inventory and price in the presence of severe financial
distress and a large fraction of strategic customers. Under optimal price and inventory decisions, strategic
waiting accounts for a large part of the firm's total cost of financial distress, although a larger proportion
of strategic customers may result in a lower probability of bankruptcy. In addition to inventory reduction
and (immediate) price discount, we find that a deferred discount, in the form of rebates and/or store credits
for future purchases, can act as an effective mechanism to mitigate strategic waiting. As a contingent price
reduction, deferred discounts align the interests of customers and the firm and are most effective when the
fraction of strategic customers is high and the firm's financial distress is at a medium level.

More Details

Item Type: Article
Subject Areas: Management Science and Operations
Additional Information:

© 2017 INFORMS

Subjects: C > Customer relations
P > Pricing
I > Inventory control
F > Financial risk
L > Liquidation
D > Disclosure of financial information
Date Deposited: 11 Jan 2017 12:08
Last Modified: 21 Jan 2020 17:31
URI: https://lbsresearch.london.edu/id/eprint/776

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