Inventory Management:

Short Life cycle product

Prof. Gourav Dwivedi
 Solution Approach:
Newsvendor Problem

https://www.youtube.com/watch?v=1T12i5Jgv80
Newsvendor Problem
• One of the most popular analytical model

• First application was seen in Edgeworth (1888) in bank note inventory

problem

• Later the standard problem was studied by Morse and Kimball (1951)

• Newsvendor has to decide optimal order quantity

Problem Characteristics
• Single period inventory system – fresh order in each period

• Demand is uncertain

• Order before demand is known

• One order per period

• Cost of over-stocking

• Cost of under-stocking
Example: Newsvendor Problem
Market price of news paper = Rs. 5.00
Cos of newspaper = Rs. 3.00
Salvage value = Rs. 2.50

Probability forecast for the newspaper

Demand, d 60 70 80 90 100 110 120 130 140

Probability 3% 6% 13% 18% 20% 15% 16% 6% 3%

Calculate Optimal Order Quantity?

Solution
Market price of news paper, P = Rs. 5.00
Cos of newspaper, C = Rs. 3.00
Salvage value, S = Rs. 2.50

Probability forecast for the newspaper

Demand, d 60 70 80 90 100 110 120 130 140

Probability 3% 6% 13% 18% 20% 15% 16% 6% 3%
F(d) 3% 9% 22% 40% 60% 75% 91% 97% 100%

Cumulative probability
Critical Ratio:
Where, Cost of Under-stocking or Underage cost

Cost of Over-stocking or Overage Cost

Probability that the demand is less than equal to

Calculations: “Stocking level is calculated by

placing unit shortage cost over the
Underage cost sum of unit shortage cost and unit
leftover cost. It represents the
optimal probability of having
Overage Cost enough, or more than enough,
products to supply. After you get
Critical ratio, stocking level and the distribution
with parameters, you can then
come up with an order quantity.” as
So the optimal order quantity corresponding to
quoted by Professor in Case: Beijing
this ratio is: units Opera Mask Sales
Calculation of Expected Profit when order quantity

Over Under Expected

Demand, d Probability Sale Pay off
Stock Stock Value

60.00 0.03 60.00 60.00 0.00 90.00 2.70

70.00 0.06 70.00 50.00 0.00 115.00 6.90
80.00 0.13 80.00 40.00 0.00 140.00 18.20
90.00 0.18 90.00 30.00 0.00 165.00 29.70
100.00 0.20 100.00 20.00 0.00 190.00 38.00
110.00 0.15 110.00 10.00 0.00 215.00 32.25
120.00 0.16 120.00 0.00 0.00 240.00 38.40
130.00 0.06 120.00 0.00 10.00 220.00 13.20
140.00 0.03 120.00 0.00 20.00 200.00 6.00
Expected Profit 185.35