L.L. Bean uses several different calculations in order to determine the number of units of a particular item it should stock, whether it is a new item or a never out item. It first freezes aforecast for its demand for the upcoming season. This figure is a result of a consensus betweenthe product people, buyers and inventory managers. Once the predicted demand is frozen, L.L.Bean uses its historical demand and forecast data to analyze the forecasting errors. The forecasterrors are calculated for each individual item and a frequency distribution of these is made,which is further used as a probability distribution for future errors. Thus, if 50% of the errorswere within 0.7 and 1.6, the forecast for this year would be adjusted accordingly. Next, each itemcommitment quantity was tabulated using its individual contribution margin and salvage value if any. For e.g. if an item had a margin of $15 if sold, and $5 loss if not sold, the commitment valuewould be 0.75. Hence the optimal stock to keep would be 0.75 fractile of the probabilitydistribution of demand. If for instance, the corresponding error for 0.75 is 1.3, the optimal stock to keep for that item would be 1.3 * frozen forecast. Hence, this value is the stock for that item.
We explain different scenarios to determine relevant costs and revenues. The first scenario iswhere the stock kept of a particular item is sold. In this case, all the costs related to buying andselling that product would be included. The selling price of the product, the cost of buying fromthe vendor, the carrying cost of that particular stock item, and the cost of marketing that item inthe catalogue are the relevant costs to be included. In the second scenario, excessive stock is keptand at the end of the season, it is still not sold. In this case, the relevant costs are the cost of buying the stock from vendor, its storage and marketing cost in the catalogue, and the salvagecost ( if any) of that particular item. In case there is no salvage cost for an item, its redundancycost becomes relevant. The final case is where the stock for a particular item is not kept, butdemand for that item is there, resulting in a stock out. Since L.L. Bean is a direct orderingcompany, the cost of a stock out is very high for it in terms of lost goodwill. Hence, the cost of goodwill lost becomes relevant in this scenario as well.