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Conditions that cause risk pooling to increase inventory

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  • Yang, Hongsuk
  • Schrage, Linus
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    Abstract

    We say product A is a partial substitute for product B if a fraction of the customers who prefer B are willing to accept A when B is out of stock. When demand is uncertain, it is intuitive and true that a larger "willing to substitute" fraction implies larger expected profits. A higher "willing to substitute" fraction allows one to pool the risk of individual products. It may also be intuitive that a larger "willing to substitute" fraction might result in lower optimal total inventory. For the full substitution structure, several researchers have shown that for certain distributions such as the exponential, this latter intuition is not true. We show that this full substitution anomaly can occur with any right skewed demand distribution. We assume i.i.d. demand distributions unless we indicate otherwise. We also show that the anomaly can occur for a number of realistic situations of partial substitution with commonly used demand distributions such as Normal, exponential, Poisson, and uniform. We also demonstrate the anomaly for more than one period, with backlogging, lost sales, more than two products, and with setup costs.

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    Bibliographic Info

    Article provided by Elsevier in its journal European Journal of Operational Research.

    Volume (Year): 192 (2009)
    Issue (Month): 3 (February)
    Pages: 837-851

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    Handle: RePEc:eee:ejores:v:192:y:2009:i:3:p:837-851

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    Web page: http://www.elsevier.com/locate/eor

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    Keywords: Inventory Demand substitution Risk pooling;

    References

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    1. Ravi Anupindi & Maqbool Dada & Sachin Gupta, 1998. "Estimation of Consumer Demand with Stock-Out Based Substitution: An Application to Vending Machine Products," Marketing Science, INFORMS, vol. 17(4), pages 406-423.
    2. Ricardo Ernst & Panagiotis Kouvelis, 1999. "The Effects of Selling Packaged Goods on Inventory Decisions," Management Science, INFORMS, vol. 45(8), pages 1142-1155, August.
    3. Gerchak, Yigal & Wang, Shaun, 1997. "Liquid asset allocation using "newsvendor" models with convex shortage costs," Insurance: Mathematics and Economics, Elsevier, vol. 20(1), pages 17-21, June.
    4. Rajaram, Kumar & Tang, Christopher S., 2001. "The impact of product substitution on retail merchandising," European Journal of Operational Research, Elsevier, vol. 135(3), pages 582-601, December.
    5. Edward Ignall & Arthur F. Veinott, Jr., 1969. "Optimality of Myopic Inventory Policies for Several Substitute Products," Management Science, INFORMS, vol. 15(5), pages 284-304, January.
    6. Ravi Anupindi & Yehuda Bassok, 1999. "Centralization of Stocks: Retailers vs. Manufacturer," Management Science, INFORMS, vol. 45(2), pages 178-191, February.
    7. Jovan Grahovac & Amiya Chakravarty, 2001. "Sharing and Lateral Transshipment of Inventory in a Supply Chain with Expensive Low-Demand Items," Management Science, INFORMS, vol. 47(4), pages 579-594, April.
    8. Kenneth R. Baker & Michael J. Magazine & Henry L. W. Nuttle, 1986. "The Effect of Commonality on Safety Stock in a Simple Inventory Model," Management Science, INFORMS, vol. 32(8), pages 982-988, August.
    9. Lingxiu Dong & Nils Rudi, 2004. "Who Benefits from Transshipment? Exogenous vs. Endogenous Wholesale Prices," Management Science, INFORMS, vol. 50(5), pages 645-657, May.
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    Cited by:
    1. Huang, Di & Zhou, Hong & Zhao, Qiu-Hong, 2011. "A competitive multiple-product newsboy problem with partial product substitution," Omega, Elsevier, vol. 39(3), pages 302-312, June.
    2. Sahba, Pedram & BalcIog[small tilde]lu, BarIs, 2011. "The impact of transportation delays on repairshop capacity pooling and spare part inventories," European Journal of Operational Research, Elsevier, vol. 214(3), pages 674-682, November.

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