ISEN 315 Spring 2011 Dr. Gary Gaukler

Newsvendor Model - Assumptions Assumptions: One short selling season No re-supply within selling season Single procurement at start of season Known costs, known demand distribution

Newsvendor Model – Continuous Demand Demand: pdf f(x) Cdf F(x) Cost parameters: overage co: cost per unit of inventory remaining at end of season underage cu: cost per unit of unsatisfied demand Total cost over season: G(Q, D)

Review the Newsvendor Solution Safety Stock –Amount of inventory held to hedge against demand uncertainty

Extension – initial inventory Assume we have initial inventory of y units

Extension – initial inventory and setup cost Assume we have initial inventory of y units, and there is a setup cost K when we order

When to Use Newsvendor Models Short selling season, no replenishment Buying seasonal goods –Fashion products Making last-run decisions –Product end of life

A Behavioral Issue Consider you are a buyer for a store that sells DVDs. You can return unsold DVDs to the wholesaler for a small restocking fee, say 20% of the wholesale cost of $5. Your profit margin on each DVD is high: $10.

Service Level of the Newsvendor What is service level? A naïve proxy: probability that demand will be less than what we stock =

Service Level of the Newsvendor What is wrong with this proxy definition of service level?

Service Level of the Newsvendor Instead, use expected fill rate as service level measure:

Demand Uncertainty How do we come up with our random variable of demand? Recall naïve method:

Demand Uncertainty

Demand Uncertainty and Forecasting Using the standard deviation of forecast error:

Example