A comparative analysis of how to handle stockout scenarios: the impact of newsvendor’s risk attitude

Abstract

The purpose of this paper is to evaluate contrasting approaches for handling excess demand through the lens of a retailer (newsvendor) whose risk attitude (risk-neutral versus risk-averse) is modeled explicitly. We employ representative newsvendor models and provide comparison between two well-established stockout policies when demand exceeds supply. The “while supplies last” policy avoids the need for a secondary production order to satisfy the excess demand but faces potential opportunity cost through lost sales. Conversely, the “accepting backorders” policy relies on recourse production availability which is potentially costly but meets all levels of realized demand. Across distinct parameter classes, we incorporate comparison between the two policies in terms of financial metrics including expected profit and conditional value-at-risk criteria as well as metrics that relate to inventory availability and, hence, customer service, e.g., stockout probabilities and expected excess inventory. Powerful analytical results encompass both financial and inventory metrics and reveal that the outperforming policy is simply determined through relative underage cost values. That is, our insights indicate general advantages of accepting backorders when profit margins are sufficiently large and advantages of ignoring excess demand when profit margins are smaller. Although these extensive analytical takeaways hold in general, our numerical study reveals mean order quantity deviations (decision bias) in addition to which modeling approaches and counterpart optimal solutions maintain outperformance (resiliency) or lead to underperformance (sensitivity) when evaluated across all objective function criteria.