Integrating early sales with production decisions: analysis and insights

Abstract

Faster product development and increased competition in retail industries is resulting in shorter and shorter product life-cycles. This phenomenon is making it more difficult for a firm to accurately estimate random demand of such products and to plan their one-time order quantity accordingly. In this paper, we develop a model to assess the multiple effects of coordinated - i.e., joint - stocking and prior-sale discount decisions: (i) on the reduction of demand uncertainty; (ii) on maximization of the expected profit; and (iii) on the probability of achieving or exceeding it. We develop the joint optimal decisions that maximize the expected profit and discuss a procedure for computing the probability that the realized value of the (random) profit will exceed its maximum expected value. We present qualitative results on the varying effects of joint decisions on increasing the expected profit and the probability of achieving or exceeding it. We also describe a detailed numerical study examining the effects of varying parameter values on the percentage increase in expected profit with joint decision making. The paper concludes with extensions of the model that can deal with more general situations.