Inventory Management under Periodic Profit Targets

Abstract

M anagers seek to meet quarterly profit targets because missing a target affects both the stock price and bonuses. To capture how these targets can affect a retailer's procurement decisions, we analyze a periodic-review inventory model with a chance constraint in each period that requires meeting a profit target with a given probability, while maximizing expected profit. Corporate profits are reported using accrual accounting, but inventory models typically use cash-basis accounting. We consider both methods. The optimal policy under accrual accounting is quite complicated, involving a state-dependent disposal policy, so we focus on the class of policies in which, in each period, the disposal quantity is increasing in the remaining inventory after demand has occurred, and show that the optimal policy consists of an orderup-to level and a dispose-down-to level in each period. These values may depend upon the constraint in that period and in all subsequent periods, so each constraint may have far-reaching effects. We also derive the optimal policy under cashbasis accounting for the infinite horizon stationary case and find that it is state-and demand dependent, even in this "easy" case. We offer insights into how the chance constraints affect the optimal procurement decisions and profits under both accounting schemes, and show that the chance constraints can lead to perverse behavior under cash-basis accounting.

Managing the Inter‐Functional Tension between Accounting‐ and Financial‐Profits in Remanufacturing Multiple‐Usecycle Products

“…They highlight several implications for assortment, advertisement and promotion, and shelf‐space allocation for retail operations. Yan et al., (2019) show how periodic accounting profit targets affect the optimal procurement decisions and profits of a firm. Tinkelman (2009) and Arya and Mittendorf (2016) analyze how cost allocation decisions in non‐profit organizations (e.g., overhead versus program expenses) impact the perception among its donors.…”

Managing Overconfident Newsvendors: A Target‐Setting Approach

“…Although various types of targets exist across organizations, particularly within marketing (e.g., KPIs on sales leads, customer acquisitions, and customer churn), targets are also prominent in driving operational decisions. Yan et al (2019) observe that aggregate procurement and production decisions by large firms (e.g., revenues exceeding 10 billion USD) are made quarterly aligning with the firms' accounting periods. They find that profit targets are often set for each product line and that key product inputs, which constrain production, are made by considering quarterly profits.…”

Data‐Driven Newsvendor Problems Regularized by a Profit Risk Constraint

“…1998, Yan et al. 2019). Many public firms manage their projects to hit and beat analysts’ earning expectations with a high probability to avoid harming their stock price (Chen et al.…”

“…However, an essential responsibility of supply chain managers is to strike a balance between profitability and financial risks (Kouvelis and Li 2019). Managers often have profit risk concerns because their compensation may be attached to the realized profit levels (Culp et al 1998, Yan et al 2019. Many public firms manage their projects to hit and beat analysts' earning expectations with a high probability to avoid harming their stock price (Chen et al 2015, Graham et al 2005.…”