### Lecture 11

```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
– 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
Example
```