Retailer Overconfidence in Demand Uncertainty and Its Supply Chain Implications

This paper studies a two-echelon supply chain in which an overconfident retailer interacts with a rational manufacturer, where the retailer’s overconfidence manifests as the underestimation of the uncertainty of market demand. The retailer is modeled as a price-setting newsvendor who makes a single ordering decision before demand is realized, and their overconfidence is captured by a mean-preserving contraction of the perceived demand distribution. The objective is to examine how this behavioral bias affects the retailer’s optimal pricing and ordering decisions and how it propagates to the manufacturer’s wholesale price decision and to the profits of the retailer, the manufacturer, and the supply chain. Prior studies of overconfident newsvendors have primarily adopted an additive demand specification and concluded that a retailer’s overconfidence is unilaterally detrimental to itself the consequences under multiplicative demand, where uncertainty concerns the market scale rather than idiosyncratic demand noise, remain underexplored. For the binary demand specification adopted in this paper, the equilibrium in a Stackelberg channel with multiplicative demand falls into three regimes—overstocking, intermediate, and understocking—determined by the unit production cost, within which the effects of the retailer’s level of overconfidence on the decisions and profits of both channel members are characterized. The analysis yields three main results. First, the retailer is not always worse off with overconfidence: in the intermediate regime, where the production cost is moderate, their profit first increases and then decreases with the level of overconfidence, so that an optimal, strictly positive degree of overconfidence exists whenever the demand volatility is not too high. Second, the manufacturer generally benefits from the retailer’s overconfidence, except in the intermediate regime with excessive overconfidence. Third, a win-win region exists in which moderate overconfidence increases both the retailer’s and the manufacturer’s profits, and mild overconfidence may even improve the profit of the whole supply chain. By identifying the conditions under which a cognitive bias improves rather than merely distorts channel performance, this paper contributes to the behavioral operations literature and suggests that discouraging a moderately overconfident retail partner is not obviously profitable within the model.