Presenter: Burak Çelik, Aalto University

Field: Operations Research

Paper: The Price of Priority: A Dual Pricing Framework for Truthful and Efficient Capacity Allocation (working paper)

Problem definition: When facing capacity shortages, suppliers often ration inventory at fixed prices to preserve channel relationships. This choice to ration, however, creates two critical inefficiencies: (i) it incentivizes retailers to inflate orders, driving the bullwhip effect, and (ii) it leads to misallocation, as scarce capacity is not directed to retailers with the highest profit margins. This paper develops a framework of practical, contract-based mechanisms that use premium pricing to eliminate order inflation and maximize supply chain profit under asymmetric information. Methodology/results: We develop two distinct dualprice allocation mechanisms. The first, the Dual-Price Uniform (DPU) rule, extends the classic uniform rule and is proven to eliminate strategic order inflation. Our equilibrium characterization of the DPU game reveals predictable strategic structures. Our second mechanism, the Modified Average Price Priority (MAPP) rule, is proven to be dominant-strategy incentive-compatible. It induces truthful revelation of both demand and private profitability to achieve first-best supply chain profit, and we establish its strategic equivalence to a Vickrey-Clarke-Groves auction. Managerial implications: Our research provides suppliers with a framework of actionable tools for managing scarcity. The DPU rule offers an operationally simple method to ensure channel stability by eliminating order inflation, and we show how suppliers can set the premium price to guarantee improved performance over the standard uniform rule. The MAPP mechanism provides a powerful tool for maximizing total supply chain profitability, enabling a decentralized channel to match the performance of a centralized system. The resulting framework allows managers to align their allocation strategy with their primary objective: achieving operational simplicity and control, or maximizing total supply chain profit.

Host: Allan Würtz