The Newsvendor Model Flashcards
Newsvendor Model
We order quantity once
We get rid of inventory after the cycle ends
We balance the price of ordering too much vs too little
D
Uncertain Demand
Cost of Overage (Co)
Overage Cost
Cost of ordering too much inventory — more than the actual demand.
➤ The cost of saving a seat for a high-paying customer who never shows up.
➤ You lose money because you didn’t sell it at all.
Co Formula
c - sv
c = wholesale value
sv = Salvage Value
Uderage Cost (Cu)
Underage cost per unit
cost of ordering too little — when you don’t have enough stock to meet demand.
➤ The cost of saying “no” to a high-paying customer because you already sold the seat cheap.
➤ You miss out on big money.
Cu Formula
p - c
p
retail price
c
wholesale cost
sv
salvage value
What is salvage value in inventory management?
It’s the money you get back for unsold products — from resale, reuse, or discount sales.
sv is 0 when ….
When they tell you that they throw away any unsold product
S
Stocking Quantity
Quantity you decide to order or stock.
What is the goal of the Newsvendor Model?
To find the optimal stock level 𝑆*
that balances the cost of:
Ordering too much (Co)
Ordering too little (Cu)
What does S* = D mean in the Newsvendor model?
If demand is known and fixed, the optimal stock level 𝑆* is exactly the demand:
𝑆* = 𝐷
Quantity to order
Mean + z-value * Std Deviation
Total Cost Formula (Random Demand):
What is the Newsvendor solution to find S*?
(Critical ratio or service level)
Pr(D≤S*)= Cu/Cu+Co
The newsvendor solution
Find the value S* that balances the marginal costs of over- and under-stocking
What do we do if demand is discrete?
Pick the smallest S where:
Pr(D≤S)≥ Cu/ Cu +Co
What do we do if demand is continuous (like normal)?
Pick any S such that:
Pr (𝐷≤𝑆) = Cu /𝐶𝑢 + 𝐶𝑜
Revenue Management
A technique used to maximize revenue when you have a fixed amount of inventory or capacity and uncertain demand.
When do we use Revenue Management?
Inventory is fixed
Items are perishable (can’t store for later)
Must commit before all demand is known
Same unit can serve multiple customer types
How does the Newsvendor Model apply to Revenue Management?
It helps decide how much inventory to reserve for high-paying customers by balancing:
Cu = Cost of turning away high-paying demand
Co = Cost of turning away low-paying sales too early
The loss if you sell too early and miss a high-paying buyer (Cu)
The loss if you save too many and they go unsold (Co)
