In this study we estimate empirically the effect of local market conditions on inventory holdings of U.S. automobile dealerships. We show that the influence of competition on a retailer's inventory holdings can be separated into two mechanisms: (1) the entry or exit of a competitor can change a retailer's demand (a sales effect); (2) the entry or exit of a competitor can change the amount of buyer stock a retailer chooses to hold, which influences the probability a consumer finds a desired product in stock (a service level effect). The sales effect can influence inventory through the presence of economies of scale. Theoretical arguments of inventory competition are ambiguous on the expected sign of the service level effect. We obtained data (via a web crawler) on inventory and sales of auto dealerships of a large manufacturer. Using cross-sectional variation of dealers in isolated markets, we estimated the effect of market structure (number and type of competitors) and sales on inventory levels. We used market population as an instrumental variable to control for the endogeneity of market structure. Our results suggest a strong positive non-linear effect of the number of rivals on service levels, an effect that is comparable to the sales effect. Counter-factual experiments indicate that reducing the dealership network of this manufacturer (thereby reducing competition) could reduce the remaining dealers days-of-supply (inventory divided by average sale rate) from 14% to 27%.
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Olivares, Marcelo, and Gerard Cachon. "Competing Retailers and Inventory: An Empirical Investigation of U.S. Automobile Dealerships." Management Science 55, no. 9 (September 2009): 1586-1604.
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