Profit Target Setting for Multiple Divisions: A Newsvendor Perspective

Managers and firms often engage in decision making based on certain profit targets. Consequently, they may adopt the objective of maximizing the profit probability, namely, the probability of achieving those profit targets. However, there has been limited research on modeling profit target setting. In this chapter, we study analytic target setting under a common business scenario where a firm owns multiple divisions. The firm sets a profit target for each division, which then decides on production level and selling price to maximize the profit probability. We obtain the divisions’ optimal profit targets in closed forms when the firm’s objective is to maximize its expected profit. When the firm’s own objective is also to maximize profit probability, the problem of profit target setting is more complicated. To gain more managerial insights, we focus on two specific cases. In the first case of fair target setting, we show that for most reasonable customer demand distributions, if a division has a relatively high (low) production cost, its assigned profit target decreases (increases) in its price elasticity. In the second case, if the firm is in control of two identical divisions, each division’s optimal profit target is just half of the firm’s profit target when the price elasticity is two or more, regardless of production cost and demand distribution. We hope that the managerial insights from this chapter help practitioners who are involved with target setting and target attainment.