Opportunity Loss Minimization and Newsvendor Behavior

Xinsheng Xu,Chi Kin Chan,Hong Yan

doi:10.1155/2017/3481869

Xinsheng Xu, Chi Kin Chan + Show 1 more

Open Access

https://doi.org/10.1155/2017/3481869

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Abstract

To study the decision bias in newsvendor behavior, this paper introduces an opportunity loss minimization criterion into the newsvendor model with backordering. We apply the Conditional Value-at-Risk (CVaR) measure to hedge against the potential risks from newsvendor’s order decision. We obtain the optimal order quantities for a newsvendor to minimize the expected opportunity loss and CVaR of opportunity loss. It is proven that the newsvendor’s optimal order quantity is related to the density function of market demand when the newsvendor exhibits risk-averse preference, which is inconsistent with the results in Schweitzer and Cachon (2000). The numerical example shows that the optimal order quantity that minimizes CVaR of opportunity loss is bigger than expected profit maximization (EPM) order quantity for high-profit products and smaller than EPM order quantity for low-profit products, which is different from the experimental results in Schweitzer and Cachon (2000). A sensitivity analysis of changing the operation parameters of the two optimal order quantities is discussed. Our results confirm that high return implies high risk, while low risk comes with low return. Based on the results, some managerial insights are suggested for the risk management of the newsvendor model with backordering.

Highlights

The newsvendor model is a main research topic in inventory management, which has been applied to various settings including production planning and yield management
We introduce a definition of opportunity loss and first obtain the optimal order quantity for a newsvendor that minimizes expected opportunity loss
To reduce the potential risks, we introduce the Conditional Value-at-Risk (CVaR) measure to quantify the potential risks

Summary

Introduction

The newsvendor model is a main research topic in inventory management, which has been applied to various settings including production planning and yield management. Khalilpourazari and Pasandideh [18] studied a multi-item multiconstrained Economic Order Quantity model with nonlinear unit holding cost and partial backordering It appears that the above papers mainly aim at maximizing the profit of a newsvendor by backlogging the unsatisfied demands or coordinating the optimal decisions of the supplier and the newsvendor in a two-echelon newsvendor model. The experimental results in Schweitzer and Cachon [19] showed that subjects behave as if their utility function incorporates a preference to reduce the absolute difference between the chosen order quantity and realized demand In light of this issue, this paper introduces the opportunity loss minimization criterion into the newsvendor model.

Model Description and Preliminaries

Minimizing Opportunity Loss in Newsvendor Model

Findings

Conclusions