ISEN 315Spring 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

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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

Example