Ratcheting of Profitability Expectations and its Consequence for Supply Chains

Fear of escalating input prices in response to retail success is a commonly discussed phenomenon affecting supply chains. Such a ratchet effect arises when a retailer feels compelled to modify its investments to better serve the end customers in order to hide positive prospects and restrain future wholesale price hikes. In a two-period model of supply chain interactions, the authors dem- onstrate that such an endogenous ratchet effect can have multifaceted reverberations. A retailer fearing price hikes may be tempted to curtail near-term profits to ensure favorable long-term pricing. In response, the supplier can use deep discounts in its initial wholesale prices to convince the retailer to focus on its short-term profits rather than long-term pricing concerns. These deep discounts not only encourage mutually beneficial investments but also alleviate double marginalization inefficiencies along the supply chain. In light of these results, the authors show that a mandatory information disclosure policy to reduce the ratchet effect decreases total channel efficiency compared with no information disclosure, precisely because mandatory disclo- sure interrupts the healthy tension among supply chain partners. Thus, the model presents a scenario in which ratcheting con- cerns can create a degree of self-enforcing cooperation that results in socially beneficial responses in supply chains