(Proofs for the proposition in Appendix E).
Proposition 1(i) generalizes the finding by Ganesh et al. [11] that substitution reduces the value of information sharing in a two-level supply chain. Proposition 1(i) shows that the value of information sharing is smaller when the products are perfect substitutes than when they are not substitutes for every level in an N-level supply chain. The reasons for the decrease in the value of information sharing under substitution are two-fold. The first is the demand pooling effect of substitution. It is well known that the pooled demand has a lower standard deviation than the sum of standard deviations of individual demands. Thus, the safety stock as well as inventory holding and shortage costs are lower when products are more substitutable and the value of information sharing is lower when the degree of substitution is higher. Second, because demand pooling caused by substitution reduces inventory holding and shortage costs even when information is not shared, the base level profit is higher when the degree of substitution is higher. A higher base level also reduces the value of information sharing, which is expressed as a percentage increase in profit.
Proposition 1(ii) shows that the reduction in the value of information sharing due to substitution is higher for more upstream firms. It is the direct result of bullwhip effect, which results in a higher demand variance for more upstream firms in the supply chain. Consequently, demand pooling effect of substitution reduces the demand variance more for more upstream firms, leading to a larger reduction in the value of information sharing because of substitution.
Proposition 1(iii) shows that the reduction in the value of information sharing due to substitution is more when product demands are less correlated. This result occurs because the reduction in demand variance because of pooling is higher when demands are less correlated.
Proposition 1(iv) shows that, the reduction in the value of information sharing due to substitution is more when the number of products is higher. Again, as the number of products increases, the pooling effect of demands will also increase.