Implementation of the Newsvendor Model with Clearance Pricing: How to (and How Not to) Estimate a Salvage Value

The newsvendor model is designed to decide how much of a product to order when the product is to be sold over a short selling season with stochastic demand and there are no additional opportunities to replenish inventory. There are many practical situations that reasonably conform to those assumptions, but the traditional newsvendor model also assumes a fixed salvage value: all inventory left over at the end of the season is sold off at a fixed per-unit price. The fixed salvage value assumption is questionable when a clearance price is rationally chosen in response to the events observed during the selling season: a deep discount should be taken if there is plenty of inventory remaining at the end of the season, whereas a shallow discount is appropriate for a product with higher than expected demand. This paper solves for the optimal order quantity in the newsvendor model, assuming rational clearance pricing. We then study the performance of the traditional newsvendor model. The key to effective implementation of the traditional newsvendor model is choosing an appropriate fixed salvage value. (We show that an optimal order quantity cannot be generally achieved by merely enhancing the traditional newsvendor model to include a nonlinear salvage value function.) We demonstrate that several intuitive methods for estimating the salvage value can lead to an excessively large order quantity and a substantial profit loss. Even though the traditional model can result in poor performance, the model seems as if it is working correctly: the order quantity chosen is optimal given the salvage value inputted to the model, and the observed salvage value given the chosen order quantity equals the inputted one. We discuss how to estimate a salvage value that leads the traditional newsvendor model to the optimal or near-optimal order quantity. Our results highlight the importance of understanding how a model can interact with its own inputs: when inputs to a model are influenced by the decisions of the model, care is needed to appreciate how that interaction influences the decisions recommended by the model and how the model’s inputs should be estimated

Optimal Pricing and order quantity strategies for a firm offering multiple products facing customers cannibalization and random market demand

This paper studies a firm’s profitability problem offering its products into different market segments at differentiated prices. In order to improve the firms’ profitability the firm needs to decide the prices and order quantities allocations for each market segment. In perfect market segmentation, it is assumed that the customers do not cannibalize between market segments. Whereas, in the case of imperfect market segmentation, the customers are assumed to cannibalize from a high price market segment to a lower price segment. Models to determine the optimal strategies for pricing and order quantity for the perfect as well as for the imperfect market segmentations are proposed with both the deterministic and stochastic customers’ demand. The study has shown that the perfect market segmentation always yields higher revenues compared to no segmentation for a firm facing both the deterministic and stochastic demand situations. In addition to this, the study has also shown that when cannibalization exists, a firm is still able to yield higher revenues compared to the case of no market segmentation facing both the deterministic and stochastic demands, however, greater the extent of cannibalization could result substantial losses in the profitability

Holiday Price Rigidity and Cost of Price Adjustment

The Thanksgiving-Christmas holiday period is a major sales period for US retailers. Due to higher store traffic, tasks such as restocking shelves, handling customers’ questions and inquiries, running cash registers, cleaning, and bagging, become more urgent during holidays. As a result, the holiday-period opportunity cost of price adjustment may increase dramatically for retail stores, which should lead to greater price rigidity during holidays. We test this prediction using weekly retail scanner price data from a major Midwestern supermarket chain. We find that indeed, prices are more rigid during holiday periods than non-holiday periods. For example, the econometric model we estimate suggests that the probability of a price change is lower during holiday periods, even after accounting for cost changes. Moreover, we find that the probability of a price change increases with the size of the cost change, during both, the holiday as well as non-holiday periods. We argue that these findings are best explained by higher price adjustment costs (menu cost) the retailers face during the holiday periods. Our data provides a natural experiment for studying variation in price rigidity because most aspects of market environment such as market structure, industry concentration, the nature of long-term relationships, contractual arrangements, etc., do not vary between holiday and nonholiday periods. We, therefore, are able to rule out these commonly used alternative explanations for the price rigidity, and conclude that the menu cost theory offers the best explanation for the holiday period price rigidity.

Why Parallel Trade may Raise Producers Profits

This paper shows that a manufacturer may benefit from parallel trade. In addition to an intuitive condition about the effect of demand shocks, this occurs when competitive retailers must order inventories before they know the realization of demand and for products whose sale value drops at the end of the demand period. For these types of products, letting retailers trade unsold inventories generally results in larger orders placed with the manufacturer, higher manufacturer profit and higher consumer surplus. The model provides a simple explanation as to why the volume of parallel trade is now very large and accepted by manufacturers for some products such as automobiles, clothes, toys, consumer electronics, musical recordings, cosmetics and perfumes.parallel trade, distribution

Essays on Operational Flexibilities in Production Planning under Supply and Quality Uncertainty

This dissertation investigates the use of operational flexibilities in production planning in order to mitigate the negative effects of supply and quality uncertainty. Uncertainties in supply and quality are commonly experienced among agro-businesses, and in particular, in the wine industry. The goal of the dissertation is to provide prescriptive solutions in mitigating such risks from the lives of agricultural businesses. The first essay of the dissertation examines the impact of supply and quality uncertainty on the investment decisions made by winemakers who lease vineyard space to grow their own fruit. At the end of the growing season, the winemaker receives an uncertain amount of high- and low-quality grapes, due to varying growing conditions such as adverse weather conditions, diseases and natural disasters. High-quality grapes are used in the making of a high-end (reserve) wine, and low-quality grapes are used for the production of a low-end wine. In this study, we investigate the benefits of the downward substitution flexibility, where the winemaker uses its excess high-quality grapes for the production of its low-end wine. In addition, we examine the influence of, and the interrelationships between, three forms of operational flexibilities: downward substitution, price-setting, and fruit trading flexibilities. The second essay of the dissertation investigates the use of advance selling to mitigate quality risk in wine production. This essay examines the influence of quality uncertainty on winemakers\u27 decisions regarding the allocation of its wine for retail operations. Specifically, we study what proportion of the wine should be sold through regular distribution channels versus what proportion should be sold as wine futures in advance of bottling. Due to the intricacies of the production method, the quality of wine may vary from the moment aging begins in the barrel to the time it is bottled and sold to the general public. This study examines the use of wine futures, whereby a winemaker sells its wine while it is still in the barrel in order to reduce the quality rating risk at the time of distribution. Overall, wine futures not only allow the winemaker to pass on the quality rating risk established through expert tastings to consumers but also let them bring in cash for immediate reinvestment into the next vintage

Electricity Restructuring: What Has Worked, What Has Not, and What is Next

In the 1990s and early 2000s, a series of state and federal initiatives restructured electric markets. In many areas of the country generation was unbundled from transmission and distribution and competitive markets for energy generation were established. A decade has now passed since many of these market reforms were implemented, and increasing energy prices have re-focused attention on these reforms. In particular, commentators are blaming the reforms for the rising energy prices and, in several states, legislators are now considering re-imposing regulation. In this paper I discuss some successful features of industry restructuring, and consider areas where further reform may be warranted. It appears that market restructuring is now producing significant tangible benefits in the areas of the country where it has been most fully implemented. Calls for the reimposition of heavy-handed regulation should be resisted.

CROSS-CULTURAL DIFFERENCES IN ONLINE PRICE ELASTICITY

This study empirically derives price elasticity estimates in fashion e-commerce in six European countries and explores their relationship within the given cultural context using Hofstede’s cultural dimensions theory. The authors use a novel data set consisting of more than two million actual sales transactions provided by a leading European fashion e-commerce company for regression analysis and find considerable cross-country differences in price elasticity. Furthermore, cultural dimensions power distance, individualism, and masculinity relate to a less distinct price elasticity whereas long-term orientation pertains to the opposite. Lastly, the study analyzes profit implications for multinational corporations employing cross-country price discrimination

Why Parallel Trade May Raise Producers' Profits

This paper shows that a manufacturer may benefit from parallel trade. In addition to an intuitive condition about the effect of demand shocks, this occurs when competitive retailers must order inventories before they know the realization of demand and for products whose sale value drops at the end of the demand period. For these types of products, letting retailers trade unsold inventories generally results in larger orders placed with the manufacturer, higher manufacturer profit and higher consumer surplus. The model provides a simple explanation as to why the volume of parallel trade is now very large and accepted by manufacturers for some products such as automobiles, clothes, toys, consumer electronics, musical recordings, cosmetics and perfumes. --parallel trade,distribution