Scrap or Sell: The Decision on Production Yield Loss

Abstract

Many production processes not only produce desired quality products (high‐end products), but also generate yield loss or Not‐Quite‐Perfect Products (NQPPs) that do not fully meet the quality standards. In practice, a manufacturer may choose to (1) scrap all NQPPs at a cost and carry the high‐end products only, or (2) sell some or all NQPPs to a value‐conscious low‐end market and carry both high‐end products and low‐end products (NQPPs). This research studies the optimal decision on production yield loss (scrap or sell) and the corresponding pricing and operational strategies under different practical situations. Building upon a standard marketing model for two separated markets, that is, the high‐end and the low‐end markets, we model the manufacturer’s profit maximization problem as a nonlinear programming problem. We characterize the optimal yield–loss decision and the corresponding optimal pricing for each market and production quantity. We also consider the situation that the NQPPs may face competition in the low‐end market with products designed and produced specifically for that market. In contrast to the common belief that selling NQPPs to a low‐end market can recover some of the cost and hence lead to a higher profit, we show that when the yield rate is small or large enough, selling NQPPs may hurt the manufacturer due to the loss of full control over both markets. This is especially true when competition exists in the low‐end market. This research provides practitioners with detailed guidelines on when and how a specific yield loss (product line or marketing) strategy should be adopted. Managerial insights are generated for the optimal yield loss strategies; numerical tests further demonstrate our results.