Optimal responses to stockouts: Lateral transshipment versus emergency order policies

Abstract

In the retail industry, stockouts have a significant effect on a firm׳s profitability. When a stockout takes place, retailers often apply one of two strategies to resolve the issue – placing an emergency order with their supplier or arranging a lateral transshipment with a nearby partner store. Choosing the optimal response to a stockout is complicated by customers׳ spontaneous reactions. Customers who find that a product is out of stock may choose to give up on the purchase, to wait for delivery (through emergency order or lateral transshipment), or go to a partner store to search for the product on their own. In this study, under a single-period setting with two retail stores, we investigate the optimal inventory decisions under each strategy, and conduct a comparison between lateral transshipment and emergency order options. We also analyze the effects of the customer requesting rate and switching rate on the optimal inventory decision. Through numerical analysis, the two strategies are compared in terms of inventory levels and profitability. The results suggest that in addition to the cost associated with each of these strategies, the customers׳ behavior in response to a stockout has a significant effect on the optimal decision. The emergency order strategy is a better option when more customers request deliveries or when more customers switch to another store. Extending this analysis, we also examine the combined strategy when an emergency order is placed after a transshipment fails to fulfill unmet demands, and explore the circumstances under which this strategy provides the highest additional profit for the stores. Finally, we also find that a higher requesting rate does not necessarily increase profits, particularly when there is a high customer switching rate, because requesting emergency order or transshipment reduces switching demand.