Channel coordination and variance reduction in a newsvendor setting

In many situations, demand risks can be reduced by investing in better forecast analytics. Investments in risk reduction usually have to be made by downstream members of the supply chain, but they affect all companies involved. Clearly, this may lead to conflicts of interests. To study how risk reduction impacts all members of a supply chain and to analyse how upstream members may give incentives to downstream members to reduce risks, this paper focuses on a single‐vendor‐single‐buyer supply chain in a newsvendor setting where the newsvendor can reduce demand risk by investing in advanced market forecast analytics and better information coordination. It is shown that these investments can improve the buyer's and the vendor's profit, which implies that both the costs and the benefits of uncertainty reduction efforts should be shared to achieve the maximum profit for the supply chain. Further, a coordination mechanism is presented that induces compliant behaviour of both actors.