An experimental study of the relationship between trust and inventory replenishment in triadic supply chain

Amin Kaboli (amin.kaboli@epfl.ch) Laboratory for Production Management and Processes Ecole Polytechnique Fdrale de Lausanne (EPFL), CH-1015 Lausanne, Switzerland Naoufel Cheikhrouhou Laboratory for Production Management and Processes Ecole Polytechnique Fdrale de Lausanne (EPFL), CH-1015 Lausanne, Switzerland Maryam Darvish Laboratory for Production Management and Processes Ecole Polytechnique Fdrale de Lausanne (EPFL), CH-1015 Lausanne, Switzerland Remy Glardon Laboratory for Production Management and Processes Ecole Polytechnique Fdrale de Lausanne (EPFL), CH-1015 Lausanne, Switzerland

Abstract

We investigate the relationship between trust and inventory replenishment decision indicators in a triadic (three-echelon) serial supply chain. We consider two types of trust; trust in supplier and trust in customer. The extant behavioral operations literature on inventory management generally ignores the role of trust on inventory replenishment decision-making. This study determines how both types of trust are built and enhanced among anonymous decision makers in a supply chain. Moreover, the trust trends moving upstream along the supply chain are identified. Results show trust in supplier and trust in customer are significantly associated to inventory managers replenishment decisions. Keywords: Trust, Inventory replenishment, behavioral operations management Introduction Consider a supply chain in which products move through multiple serial echelons before they are finally shipped to the end customer. In such a serial multi-echelon inventory system, humans (inventory managers) make dynamic decisions, called inventory replenishment decisions, to regulate the inventory levels, minimize total costs, and satisfy downstream customer demand. These decisions are in response to two fundamental questions: first how much should the replenishment order quantity be? And second when should a replenishment order be placed? In a normative (analytical models) viewpoint, the decision maker (inventory manager)

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is perfectly rational and is able to find the optimal inventory replenishment policy or policies (Simon 1982). Whereas, in a behavioral perspective, the decision maker is at best bounded rational, which means s/he has a restricted capacity to tackle complex problems such as inventory replenishment decisions (Gino and Pisano 2008). In addition to the complexity and dynamic nature of continuous inventory replenishment decisions in supply chain, behavioral factors such as trust play a significant role in the decision making process. The level of trust among supply chain echelons has a dual and complex effect on performances. On the one hand, it guards supply chains against high inventories and poor customer services and on the other hand, lack of trust can cause demand amplification and intensify supply chain distortion leading to higher inventories and lower customer services (Sterman 2006). Although there is a general agreement among researchers about the role of trust in supply chain, there is still little accordance about trust measurement. Previous researches address trust in supply chain mostly with the aid of surveys, interviews and field data analysis. Furthermore, there are few studies based on laboratory experiments regarding the role of trust in supply chain. The primary objective of the present research is to explore the link between trust and inventory replenishment indicators (order quantity and time between orders) in triadic supply chain. This paper aims to answer four basic research questions. First, can anonymous decision makers build (or generate) and maintain trust in supply chain? Second, what are the trust trends while moving upstream along the supply chain? Third, what is the relationship between trust in supplier and inventory replenishment decision indicators? Fourth, what is the relationship between trust in customer and inventory replenishment decision indicators? Trust and inventory replenishment Many studies argue that trust is a fundamental ingredient in building and maintaining cooperation (Kumar, 1996; Bachmann 2001; Spekman et al. 1998; Cheikhrouhou and Pouly 2012). Trust can reduce perceived relational risk by increasing confidence in supplier or customer good intention (Das and Teng 1998), and is based on a rationale that increasing confidence will facilitate deeper commitment between echelons. Furthermore, trust can significantly contribute to the long-term stability of a supply chain (Handfield and Bechtel 2002). Measuring and monitoring trust perception is an important issue for enterprises. Conducted studies so far, depending to the researchers background, implement different tools and methods (Seppanen et al. 2007). The economic approach to trust is calculative and experimental. To measure trust economists consider trust as the focus on testing Nash Equilibrium and showing there is a conflict between theory and actual behavior which is called paradox of backward induction (Camerer and Weigelt 1988, Rosenthal 1982, McKelvey and Palfrey 1992, Ozer et al. 2010). In operations management studies, researchers use different research tools including interviews, field data analysis, and surveys, which the former one is the most common and widely used method among the others (Sako, 1994, Currall and Judge 1995, Doney and Cannon 1997, McEvily and Tortoriello 2011). Recently experimental studies have drawn considerable attention in behavioral operations management terrain. One operations problem in which laboratory experiment

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has been frequently used is order quantity oscillation and amplification along the chain called bullwhip effect. Using the beer distribution game, Sterman (1989) studies misperception of feedback in inventory replenishment decision-making. He identifies underweighting the supply line is the cause of the observed instability in supply chains. The most inventory replenishment literature extant investigates information delay. Gupta et al. 2001, Croson and Donohue 2003, Steckel et al. 2004 consider sharing the point of sale data, Machuca and Barajas 2004 review the use of electronic data interchange, Croson and Donohue, 2006 examine sharing the status of the inventory. Another group of studies investigates the effect of reducing inventory replenishment delays (Kaminsky and Simchi-Levi 2000, Kimbrough et al, 2002, Steckel et al. 2004). Furthermore, Wu and Katok (2006) study the effect of communication and learning. Oliva and Goncalves (2007) examine different response to own on-hand inventory and backorders and Croson et al. 2012 investigate the role of coordination stock on stability of supply chain. Also, in an interesting study Rong et al. (2008) consider the reactions to supply and demand uncertainty and introduce reverse bullwhip effect. In spite of the vast focus of literature on order quantity oscillation and amplification, there is scarce evidence of the relationship between trust and both inventory replenishment decision indicators; order quantity and time between orders in the supply chain literature. We contribute to this literature by studying trust as an important behavioral factor in inventory management, and by investigating how this behavioral phenomenon can be related to inventory replenishment decision indicators. Using laboratory experiment as the research tool and measuring decision makers trust perception with survey, the present work is one of the very first research papers implementing laboratory experiment to explore the link between trust and inventory replenishment decision. The next section addresses the proposed approach to investigate the link between trust perceptions of each echelon with its own inventory replenishment decisions in a decentralized supply chain. Methodology and experimental design To illustrate triadic (three-echelon) serial supply chain we use an extended version of the beer distribution game, called XBeerGame, (Montreuil et al. 2008). Figure 1 shows the structure of the experiment. It is worth noting that computer agents play the factory and market roles and human participants play the rest.
Trust in supplier (Tsd) Trust in supplier (Tsw) Trust in supplier (Tsr)

Factory

Distributor

Wholesaler

Retailer

Market

Trust in customer (Tcd) Trust in customer (Tcw) Trust in customer (Tcr)

Figure 1: The structure of the experiment

A commonly agreed definition of inter-firm trust with the following definition is adopted: one echelons belief that its needs will be fulfilled in the future by actions undertaken by the other echelon (Anderson and Weitz, 1989). Since the features of trust in a supplier and customer are different, two questionnaires, forms A and B, are

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developed to capture trust perception of a decision maker regarding his/her supplier or customer, respectively. Owing to the fact that trust is inherently context dependent, trust items were pooled from organizational inter-firm trust literature (Seppnen et al. 2007, Doney and Cannon 1997, Currall and Epstein 2003) to prepare a list of items. Then, experts evaluated the list of selected items. Based on the experimental setting, local information availability, and multi-echelon supply chain context, the four following items: intention, competence, commitment, and reputation were selected to build the trust construct. Participants comments and feedback from different pilot studies also helped to re-structure forms A and B. Statements related to these four items are tabulated in Table 1.
Table.1. Item statements in forms A and B Intention Form A: trust in supplier My supplier will not use opportunities that arise to take advantage at my expenses My supplier knows how to efficiently manage his/her company My supplier is committed to ontime delivery My supplier has reputation for ontime delivery Form B: trust in customer My customer will not use opportunities that arise to take advantage at my expenses My customer is able to efficiently manage his/her company My customer is committed to stable ordering patterns My customer has reputation for stable ordering patterns

Competence Commitment Reputation

The experiment proceeds as indicated in Table 2: Participants enter the experimental laboratory at an appointed time and are randomly assigned to a game. Before starting the game, each participant is provided with a handout (4-5 pages) explaining the experimental procedure. After reading the instructions, participants questions are answered and after a debriefing, the game and simulation interface are presented.
Table.2. Overview of the experimental procedure # 1 2 3 4 6 7 8 Activity Laboratory entrance Reading the handout Debriefing Interface presentation Warm-up exercise Main experiment Post experiment questionnaire Estimated Time 15 min 30 min 30 min 20 min 25 min 55 min 15 min

To become familiar with the simulation interface and game dynamics, participants are asked to play the game for a short warm-up period. After warm-up, the main experiment is run. To evaluate the evolution of trust during the game, the experiment is divided into eight rounds of approximately seven minutes, providing eight trust measurements for

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each decision maker. The game is stopped at the beginning of each round. At each stop, participants are asked to fill out form A (customer trust in his/her supplier) and form B (supplier trust in his/her customer) based on a 7-point Likert scale (1 representing strongly disagree and 7 representing strongly agree). At the end of the game, participants are asked to fill a post-experiment questionnaire and explain their replenishment decision strategy or strategies. To avoid an end of the game effect, the duration of the game is not announced in advance. Result and discussion All reports of data are aggregated to the role (echelon) level by taking the mean and standard deviation of the participants in each role per round over the game. To assess how trust in supplier and trust in customer are built and maintained among anonymous decision makers and what the trust trends are while moving upstream along the supply chain, descriptive statistics of 12 supply chains (36 players) over 8 rounds (96 observations for each role) are presented in the following sections. Furthermore, to investigate the relationship between trust in supplier, trust in customer, and inventory replenishment decision indicators a role-based Spearman rank correlation is performed. Trust The mean () and standard deviation () of trust in supplier (Ts) and trust in customer (Tc) over the game for each role are presented in Table 3. A visual inspection among the roles on Table 3 shows that distributor and retailer have the highest Ts and Tc respectively (with the smallest ). One possible explanation could be due to the fact that computer agents play factory and market roles. Although this information was not announced to the players during the experiment, distributor and retailer could take advantage of the computer agent regular behavior.
Table 3: The overall mean and standard deviation of trust per round Number of observations (N) Retailer Wholesaler Distributor 96 96 96 Trust in supplier Trust in Customer

Ts
4.46 4.06 4.64

Ts 1.34 1.41 1.19

Tc
4.57 4.01 3.69

Tc 1.13 1.63 1.34

The results of Mann-Whitney U-test (Seigel 1965) show that Ts for wholesaler is the least among the roles (Ts is significantly higher for retailer than for wholesaler, z = 2,187, p < 0.05 and Ts is significantly higher for distributor than for wholesaler, z = .2,997, p < 0.01). Moreover, the same test indicates Tc is significantly higher for retailer than for wholesaler (z =- 2,227, p < 0.05). Though Tc is smaller for distributor than for wholesaler, Mann-Whitney U-test does not point out significant difference between them (z = -. 1,541, p = 0.123). Furthermore, an overall look on Table 3 indicates that for all roles; Ts > 4 and Tc>4 (except for distributor Tc). This fact answers our first research question and denotes that trust is built between anonymous decision makers over time. To assess the trend of trust in supplier and trust in customer, the mean trust values of 5 !

each role per round over the game are illustrated in Figure 2 and Figure 3. A visual inspection on Figure 2 shows similarities of the evolution of trust in supplier among the roles. The starting points for retailer, wholesaler and distributor are pretty close (3.98, 4.02 and 3.77 respectively) and they end up in higher levels than their own starting point. Among all the roles, distributors trust in supplier generally stays above the others.
( '
Mean trust in supplier (Ts)

& % $ # " " # $ % & ' ( )

Round

*+,-.+/0-1. 23145,645. 75-6+45.

Figure 2: Trend of trust in supplier per round over the game

Trust in customer evolves and enhances for all three roles over the game as depicted in Figure 3. Tc for each role starts from the below average and ends up at a higher level of its own mean. Among all the roles, retailer persistently stays above the others.
(
Mean trust in customer (Tc)

' & % $ # " " # $ % & ' ( )

Round

*+,-.+/0-1. 23145,645. 75-6+45.

Figure 3: Trend of trust in customer per round over the game

Inventory replenishment We consider continuous inventory replenishment in this research. Therefore, both order quantity and replenishment time are variable. The mean () and standard deviation () of

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received order quantity (ROQ), placed order quantity (OQ), time between received orders (ROT), as well as time between placed orders (OT) are tabulated in Table 4. Results show that mean and standard deviation of inventory replenishment decision indicators for each role increase while moving up along the supply chain, from retailer to distributor. This increase on the dynamics of orders (received and placed) indicates a demand amplification and distortion while moving from market to upstream supplier.
Table 4: Inventory replenishment decision indicators, by role Number of Observations Retailer Wholesaler Distributor (N) 96 96 96 Order quantity ROQ 1508 3796 5892 ROQ 32.98 4931 5097 OQ 3796 5892 7088 OQ 4931 5097 6270 Time between orders ROT 11.98 26.35 51 ROT 0.14 20.46 53.18 OT 26 51 60 OT 20.38 53 54

To analyze the variability in inventory replenishment decision indicators among the roles the coefficient of variation (CV) is calculated as the ratio of the standard deviation over the mean (Fransoo and Wouters 2000, Baganha and Cohen 1998). The obtained results are summarized in Table 5.
Table 5: Variability in inventory replenishment decision indicators, by role Variability in replenishment time Variability in order quantity
High (CV100%) Low (0% CV100%) Low (0% CV100%) High (CV100%)

Distributor

Retailer Wholesaler

While market demand (retailers ROQ and ROT) has low variability (CVOQm = 2.19%, CVOTm = 2%), retailer places orders with higher variability on OQ and OT than market demand (CVOQr = 130%, CVOTr = 78%). Wholesaler receives these fluctuating orders from retailer and decreases the variability of OQ but increases the variability of OT (CVOQw = 86%, CVOTw = 104%). Wild swinging wholesaler queries with high variability on time between orders reach to distributor. Results show that distributor decreases the variability of OQ and OT (CVOQd = 88%, CVOTd = 90%). The link between trust and inventory replenishment decision Table 6 shows the obtained Spearman rank correlation by role. Results for retailer show that inventory replenishment decision indicators are negatively correlated with both trust types. However, there is no significant association between OT, Ts and Tc. Results for wholesaler indicates there is a positive relationship between Ts, OQ, OT and OT. However, no significant correlation between Ts and order quantity variability (CVOQ) is found. Results for distributor show that trust in supplier (Ts) is negatively correlated with OT and trust in customer (Tc) is negatively associated with all inventory replenishment decision indicators, except for OT.

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Table 6: Spearman rank correlation table Trust in supplier OQ

***

Trust in customer OT OQ
***

OQ
***

OT
***

OQ -.381 -.096 -.311***

***

OT -.306 .186* -.176*

***

OT -.056 -.306*** -.135

-.355 Retailer -.332 -.305 -.310 -.085 *** *** * Wholesaler .278 .014 .294 .200 .140 Distributor -.169 -.138 -.122 -.195* -.275*** * Correlation is significant at the 0.1 level (2-tailed). **!Correlation is significant at the 0.05 level (2-tailed). ***!Correlation is significant at the 0.01 level (2-tailed).

In our experiment each player makes inventory replenishment decision that consists of two components: order quantity and time between orders. According to results, retailer perceive low market demands as wild swinging orders and increases the variability of order quantity and time between orders. This volatile ordering behavior is negatively associated with the both trust perceptions on players mental model and leads retailer to boost order quantity and time between orders. Retailers expected orders fail to receive on time due to large backlog on wholesaler and distributor. Wholesaler smoothes the variability of order quantity but increases the variability of time between orders to guard against retailers volatile ordering behavior. Thus places relatively a low variance but high order quantity in different time intervals. Wholesaler trust in customer is negatively correlated to retailer variability in time between orders (r = -.342, p < 0.05). However, wholesaler trust in supplier pattern is different. One possible explanation is due to the fact that wholesaler filters retailer highly variable orders (in quantity) and transforms them into highly variable orders in time. This fact gives a demand signal of large order quantities with variable time intervals to the distributor. Thanks to the computer agent on factory role, distributor could build up more on hand inventory with less supplier delivery delays. Thus, distributor regulates this signal by smoothing the variability in order quantity and time between orders. This ordering behavior of distributor is negatively associated with the both trust perceptions and leads him to face with compensating feedback, the more buffer to keep as on hand inventory, the higher cost to pay as holding cost. Due to distributors high level of on hand inventory, there is higher chance for wholesaler to receive his placed orders on time. This situation could give him the sense of getting what he expected which leads to his different trust in supplier perception. Conclusion This research is designed to examine the relationship between trust and inventory replenishment decision. We create an experimental setting where there are unknown market demands and local information availability. Communication is not possible, and in fact participants interact anonymously and never find out with whom they play. Our experiment has additional desirable features. It allows us to untangle order quantity and time between orders (order time intervals). Delineating order quantity from time between orders is important because they are fundamentally different; most previous research on behavioral operations management studies entangles the two. Besides, it allows us to differentiate and examine trust in supplier and trust in customer. We contribute to the extant literature in two ways. First, we propose a combined 8 !

experimental approach (experiment and survey) to measure trust and assess how trust is built, maintained, and evolved. Second, considering the dynamics of trust over the game, we study an important issue: the relationship between trust and inventory replenishment decision which has not been investigated much in prior studies. Acknowledgement The authors gratefully acknowledge financial support from the Swiss National Science Foundation Grant No. [100014_130053/1]. They are thankful to Benoit Montreuil and his team at University Laval for providing the XBeerGame platform and helping in its adaptation. Also, the authors wish to thank Christopher L. Tucci for his constructive and helpful suggestions. References
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