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Inventory Management Under Market Size Dynamics

Author

Listed:
  • Tava Lennon Olsen

    (Olin Business School, Washington University in St. Louis, St. Louis, Missouri 63130)

  • Rodney P. Parker

    (The University of Chicago Graduate School of Business, Chicago, Illinois 60637)

Abstract

We investigate the situation where a customer experiencing an inventory stockout at a retailer potentially leaves the firm's market. In classical inventory theory, a unit stockout penalty cost has been used as a surrogate to mimic the economic effect of such a departure; in this study, we explicitly represent this aspect of consumer behavior, incorporating the diminishing effect of the consumers leaving the market upon the stochastic demand distribution in a time-dynamic context. The initial model considers a single firm. We allow for consumer forgiveness where customers may flow back to the committed purchasing market from a nonpurchasing "latent" market. The per-period decisions include a marketing mix to attract latent and new consumers to the committed market and the setting of inventory levels. We establish conditions under which the firm optimally operates a base-stock inventory policy. The subsequent two models consider a duopoly where the potential market for a firm is now the committed market of the other firm; each firm decides its own inventory level. In the first model, the only decisions are the stocking decisions and in the second model, a firm may also advertise to attract dissatisfied customers from its competitor's market. In both cases, we establish conditions for a base-stock equilibrium policy. We demonstrate comparative statics in all models.

Suggested Citation

  • Tava Lennon Olsen & Rodney P. Parker, 2008. "Inventory Management Under Market Size Dynamics," Management Science, INFORMS, vol. 54(10), pages 1805-1821, October.
    • Handle: RePEc:inm:ormnsc:v:54:y:2008:i:10:p:1805-1821
    DOI: 10.1287/mnsc.1080.0889
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    References listed on IDEAS

    as
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