’the Newsvendor Problem

Problem 1:

Problem # 1 illustrates the logic of the ‘’The Newsvendor Problem”.The Newsvendor problem enables us to identify the optimal stocking quantity for a perishable product with an unpredictable demand., and a single stocking decision  made prior to observing any demand (i.e., no replishment).

Using the simulation in the spreadsheet  Hamptonshire Express  # 1, we observe the relationship  between the stocking quantity  and Sheen’s profits.

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First notice the optimal stocking quantity  ( 584units ) is not equal to the mean demand of 500, because the cost of overstocking  is not equal to the  cost of understocking.In problem # 1, the understocking  cost is equal  to $0.80($1-0.20) per unit of unmet demand , while the overstocking cost is only $0.20 per newspaper.

We can also see that the fill rate ( the expected fraction of demand  that Sheen can satisfy from inventory) increases as Sheen stocks more newspapers .However the fill rate increases more slowly at higher levels  of Q-while the first 100 units of stock increase  the fill rate from  0% to 21%, increasing  the stocking  quantity ffrom  500 to 600 the fill rate by only approximately 6% ( from 93% to 99%).Sheen is less likely to sell the marginal stocking quantity  at higher values of Q, and hence , these units are less likely to increase her fill rate.

Sheen’s profit increases from a loss  of $40/day (when the stocking quantity is 0) to $332/day (when Sheen stocks  584 newspapers).The profit declines to $259(when Sheen stocks  1000 units, at the beginning of each day).This pattern is consistent  withe the newsvendor model. At low levels of  Q (i.e. close to 0) , Sheen sells few newspapers (i.e. loses sales )due to inadequate inventory  and thus has low profit.Additional units increase Sheen’s expected sales , but also lead to more unsold inventoy,and thus higher overstocking costs.To identify optimal stocking quantity , Sheen has to trade-off the expected understocking cost , against the expected the overstocking cost.Since the cost of understocking  ($0.80 per unit ) is more than the cost of overstocking  ($0.20 per unit ), the profit function is maximized  at a stocking quantity  (584 units) that exceeds the mean.

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