Optimal Ordering Policy of a Risk-Averse Retailer Subject to Inventory Inaccuracy

Abstract

Inventory inaccuracy refers to the discrepancy between the actual inventory and the recorded inventory information. Inventory inaccuracy is prevalent in retail stores. It may result in a higher inventory level or poor customer service. Earlier studies of inventory inaccuracy have traditionally assumed risk-neutral retailers whose objective is to maximize expected profits. We investigate a risk-averse retailer within a newsvendor framework. The risk aversion attitude is measured by conditional-value-at-risk (CVaR). We consider inventory inaccuracy stemming both from permanent shrinkage and temporary shrinkage. Two scenarios of reducing inventory shrinkage are presented. In the first scenario, the retailer conducts physical inventory audits to identify the discrepancy. In the second scenario, the retailer deploys an automatic tracking technology, radiofrequency identification (RFID), to reduce inventory shrinkage. With the CVaR criterion, we propose optimal policies for the two scenarios. We show monotonicity between the retailer’s ordering policy and his risk aversion degree. A numerical analysis provides managerial insights for risk-averse retailers considering investing in RFID technology.