The pricing and sourcing strategies of competitive retailers under supply disruption in the presence of liquidated damages

Supply disruptions often make retailers face stock-outs and lead to higher selling price, which forcing retailers to adopt optimal sourcing strategies to avoid disruptions and carefully adjust their pricing when disruptions occur to achieve ideal profits in competition with other peers. In this paper, we optimize the combination of pricing levels and sourcing strategy of the competitive retailer having choices of cost or stable supplier when supply disruptions occur with the consideration of liquidated damages. Based on the procurement costs difference between retailers and competitors, we studied the optimal sourcing and pricing strategies under two types of Stackelberg game and one type of Nash game. We find that the Nash Equilibrium leads lower selling prices for retailers and larger purchases from cost suppliers compared to the Stackelberg game, but with the increase of retailer’s market potential, retailers gradually depend on stable suppliers. We also find that liquidated damages can have a significant impact on retailers’ decisions. Specifically, when the probability of disruption is high, retailers will mainly rely on stable suppliers in the presence of no liquidated damages, while in the case of liquidated damages, retailers will instead rely on cost suppliers. Furthermore, as liquidated damages increase, retailers prefer to source from cost suppliers and use very high price adjustments to account for supply disruptions. Especially when the risk of disruption is high, retailers rely mainly on cost suppliers and super high price adjustments. This highlights the critical role of liquidated damages on retailers’ optimal pricing and sourcing strategies.