Integrating the Promotional and Service Roles of Retail Inventories

Abstract

In some retail contexts, higher inventories not only improve service levels, but also stimulate demand by serving as a promotional tool (e.g., by increasing product visibility). Motivated by a building-products retailer's practice of stocking large quantities of products to stimulate demand, we study inventory management and pricing policies when demand is uncertain but increases with stocking quantity. We first characterize the profit-maximization policy for a stochastic inventory model with a general inventory-dependent demand distribution and given price, and show that demand stimulation (by inventories) has the effect of increasing the target service level beyond the classical newsvendor model's critical fractile ratio. To underscore the importance of considering both demand stochasticity and inventory influence, we consider two functionally oriented benchmark policies--a demand-driven policy and a critical fractile policy--that might, respectively, represent marketing and inventory managers' viewpoints. Our numerical analysis reveals that the optimal policy can generate considerably higher profits than the two complementary functional perspectives. Moreover, we prove that the optimal stocking quantity always exceeds the critical fractile solution and can even exceed the demand-driven stocking quantity. We also address the problem of jointly optimizing both stocking quantity and price for demand-stimulating products using a multiplicative model to represent the influence of price and stocking quantity on the demand distribution. For this model, we show that the pricing and stocking decisions can be determined sequentially, with the optimal policy setting higher prices and stock levels than both the functional policies.retail operations, inventory management, pricing, newsvendor model, promotional inventories

The Effect of Inventory Level on Product Availability and Sale

“…Besides improving service levels, higher inventories can increase sales through stimulating customer demand by serving as a promotional tool (Balakrishnan, 2008). According to Dana and Petruzzi (2001), customers are more willing to visit the store where they expect higher service levels.…”

The newsvendor problem: Review and directions for future research

“…Balakrishnan, Pangburn and Stavrulaki [9] generalized the newsvendor model to incorporate the stochastic and initial-stock-level dependent demand. The authors proposed a general stochastic demand model via an inverse fractile function to capture the stimulating effect of stock on demand.…”

“…To solve the buyer's optimal order quantity decision (Q * IU ) assuming that the supplier offers an incremental quantity discount, the algorithm shown in Figure 3 can be used. 9 Insert Figures 2 and 3 While price break quantities can be candidates for the global optimum in the case of all-units quantity discount, the paper mentioned that we only need to pay attention to the intersections when an incremental quantity discount is considered.…”

Substitution Effects in Supply Chains with Asymmetric Information Distribution and Upstream Competition

“…Third, production quantities exert a stimulating effect on the wholesaler's stocking decision, i.e. stocking levels stochastically increase with the available production quantities, but at a decreasing rate (for a thorough discussion on stimulating effects of inventories, see Balakrishnan et al, 2008).…”