Lecture 11

ISEN 315
Spring 2011
Dr. Gary Gaukler
Newsvendor Model - 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
• 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
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
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:

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