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# Newsvendor

Newsvendor Model
Model with
with Demand
Demand Diversion
Diversion

This
Thismodel
modelillustrates
illustratesthe
thefamous
famousnewsvendor
newsvendorordering
orderingmodel
modelin
inaamultiple-product
multiple-productsetting
settingwith
with
means
that
if
supply
of
product
A,
say,
is
not
sufficient
to
satisfy
demand
for
product
means that if supply of product A, say, is not sufficient to satisfy demand for productA,
A,some
somecu
cu
product
A
but
couldn't
get
it
are
willing
to
purchase
another
product
A
general
model
of
product A but couldn't get it are willing to purchase another product instead. A general model o
allowed
allowedto
toswitch
switchto
toany
any other
otherproduct
productin
instock,
stock,isisquite
quitecomplicated,
complicated,so
sothe
thecurrent
currentmodel
modelmake
mak
will
switch
only
to
his
or
her
next
favorite
product,
and
that
the
favorites
come
in
nonoverlappin
will switch only to his or her next favorite product, and that the favorites come in nonoverlappi
means
meansthat
thatunsatisfied
unsatisfieddemand
demandfor
forAAcan
canbe
bediverted
divertedto
toBBand
andvice
viceversa,
versa,unsatisfied
unsatisfieddemand
demandfo
f
so
on.
This
might
be
the
case,
for
example,
where
A
and
B
are
two
brands
of
13-inch
laptops,
so on. This might be the case, for example, where A and B are two brands of 13-inch laptops,an
an

Now
Nowconsider
considerany
anypair
pairof
offavorites,
favorites,such
suchas
asAAand
andB.
B.Let
LetOA
OAand
andOB
OBbe
bethe
theorder
orderquantities
quantitiesfor
forAA
AAand
B.
Then
are
four
possibilities:
(1)
Insufficient
supply
of
each
product,
OA<DA
and
OB<DB.
and B. Then are four possibilities: (1) Insufficient supply of each product, OA<DA and OB<DB.
diversion
diversiontakes
takesplace.
place.(2)
(2)At
Atleast
leastenough
enoughsupply
supplyof
ofeach
eachproduct,
product,OA>=DA
OA>=DAand
andOA>=DB.
OA>=DB.Then
Then
inequalities
inequalitiesare
arestrict),
strict),but
butno
nodiversion
diversiontakes
takesplace.
place.(3)
(3)Insufficient
Insufficientsupply
supplyof
ofA,
A,more
morethan
thanenoug
enou
DA-OA
customers
can
divert
to
B,
at
least
until
supply
of
B
runs
out.
(4)
This
is
the
mirror
image
DA-OA customers can divert to B, at least until supply of B runs out. (4) This is the mirror image
you
yousee
seenow
nowwhy
whyaa"general
"generaldiversion"
diversion"model
modelwould
wouldbe
beso
socomplex?)
complex?)

The
Themodel
modelon
onthe
thenext
nextsheet
sheetassumes
assumesthat
thatthere
thereare
arethree
threepairs
pairsof
ofproducts,
products,AAand
andB,
B,CCand
andD,
D,aa
independent,
independent,all
allfrom
fromPert
Pertdistributions
distributionswith
withthe
theparameters
parametersgiven.
given.Make
Makesure
sureyou
youstudy
studythe
thelogi
log
this
model
are
easy
to
make!
this model are easy to make!

RISKOptimizer
RISKOptimizercan
canthen
thenbe
beused
usedto
tofind
findthe
theorder
orderquantities
quantitiesthat
thatmaximize
maximizemean
meanprofit.
profit. The
Theord
ord
to
the
most
likely
demands.
These
are
not
terrible
choices,
but
by
running
RISKOptimizer,
to the most likely demands. These are not terrible choices, but by running RISKOptimizer,you
yoush
s
improvement.
improvement.
Note:
Note: The
TheIndustrial
Industrialedition
editionisisrequired
requiredto
touse
usethe
theRISKOptimizer
RISKOptimizerfeature
featureof
of@RISK.
@RISK.

le-product setting
ple-product
settingwith
withthe
thepossibility
possibilityof
ofdemand
demanddiversion.
diversion.This
This
for
product
A,
some
customers
(but
not
all
of
them)
d for product A, some customers (but not all of them)who
whowanted
wanted
generalmodel
modelof
ofdemand
demanddiversion,
diversion,where
diverter isis
the
current
model
makes
the
simplifying
assumption
the current model makes the simplifying assumptionthat
diverter
come
in
nonoverlapping
pairs:
A
and
B,
C
and
D,
and
s come in nonoverlapping pairs: A and B, C and D, andso
soon.
on.This
This
, unsatisfied
a,
unsatisfieddemand
demandfor
forCCcan
canbe
bediverted
divertedto
toDDand
andvice
viceversa,
versa,and
and
s of
ds
of13-inch
13-inchlaptops,
laptops,and
andCCand
andDDare
aretwo
twobrands
brandsof
of15-inch
15-inchlaptops.
laptops.

e order
he
orderquantities
quantitiesfor
forAAand
andB,
B,and
andlet
letDA
DAand
andDB
DBbe
bethe
thedemands
demandsfor
for
t,
OA<DA
and
OB<DB.
Then
there
are
leftovers
for
A
and
ct, OA<DA and OB<DB. Then there are leftovers for A andB,
B,and
andno
no
DA
DAand
andOA>=DB.
OA>=DB.Then
Thenthere
thereisislost
lostdemand
demandfor
forAAand
andBB(if
(ifthe
the
y
lyof
ofA,
A,more
morethan
thanenough
enoughof
ofB,
B,OA<DA
OA<DAand
andOB>DB.
OB>DB.Then
Theneach
eachof
ofthe
the
his
is
the
mirror
image
of
(3)
with
the
roles
of
A
and
B
reversed.
(Do
This is the mirror image of (3) with the roles of A and B reversed. (Do

cts, AAand
ucts,
andB,
B,CCand
andD,
D,and
andEEand
andF.F.Demands
Demandsfor
forthe
theproducts
productsare
are
esure
sureyou
youstudy
studythe
thelogic
logic,,especially
especiallyin
inrows
rows17-20.
17-20.Formula
Formulaerrors
errorsin
in

ze
zemean
meanprofit.
profit. The
Theorder
orderquantities
quantitiesin
inrow
row12
12are
arecurrently
currentlyset
setequal
equal
g
RISKOptimizer,
you
should
that
there
is
definitely
room
for
ng RISKOptimizer, you should that there is definitely room for

eeof
of@RISK.
@RISK.

Inputs
Product
Min demand
Most likely demand
Max demand
Diversion probability
Unit cost
Unit price
Salvage value

A
500
1,000
2,000
0.6
\$10
\$16
\$5

B
450
950
1,700
0.5
\$15
\$22
\$5

C
400
900
1,600
0.7
\$25
\$34
\$8

D
350
850
1,500
0.6
\$35
\$45
\$8

E
300
800
1,300
0.5
\$50
\$65
\$12

Order quantity

1,000

950

900

850

800

Simulation
Product
Original demand
Diversion possible?
Number willing to divert
Number who divert
Final demand
Revenue
Cost
Salvage
Profit

A
796
No
0
0
889
\$14,224
\$10,000
\$555
\$4,779

B
1140
Yes
93
93
1047
\$20,900
\$14,250
\$0
\$6,650

C
1064
Yes
110
110
954
\$30,600
\$22,500
\$0
\$8,100

D
740
No
0
0
850
\$38,250
\$29,750
\$0
\$8,500

E
533
No
0
0
538
\$34,970
\$40,000
\$3,144
-\$1,886

\$45,767

F
250
750
1,200
0.4
\$55
\$75
\$14
750

F
Totals
758
5,031
Yes
5
208
5
208
753
5,031
\$56,250 \$195,194
\$41,250 \$157,750
\$0
\$3,699
\$15,000 \$41,143