A New Approach to Stockout Penalties

Abstract

Classical inventory theory considers that stockouts generate penalty costs to the firm, often assumed to be proportional to the excess of demand over supply. While such a concept is sometimes appropriate, it does not correctly reflect the effect of loss of goodwill. The latter is characterized by the fact that a disappointed customer reacts in the future to change his purchasing habits. Thus the nature of the effect is that subsequent demand is perturbed, a phenomenon quite different from having an immediate penalty cost imposed. Models with this property are termed perturbed demand, abbreviated PD. In this paper, this concept is defined precisely, and some of its properties are developed. Some typical cases are solved to determine optimal policies when PD prevails.

Mobile Money: The Effect of Service Quality and Competition on Demand

“…This paper provides empirical support to Schwartz's (1966) theoretical prediction that stockouts would alter future demand. As Anderson et al (2006) showed was the case with mail-order catalogs, we find that mobile money agents in Kenya and Uganda who stock out more often experience lower steady-state demand.…”

“…The loss of future demand due to stockouts can be more difficult to estimate. Schwartz (1966) coined the term "perturbed demand" in his seminal work modeling the loss of consumer goodwill that a firm experiences in the aftermath of a stockout. "Perturbed demand" refers to the decrease in future demand, where this decrease is a function of the magnitude of the stockout.…”

“…Schwartz (1966) theorizes in his perturbed demand model that customers will decrease their patronage of firms that disappoint them by stocking out of desired products. Anderson et al (2006) show that customers who experienced stockouts do indeed purchase less in the future.…”

Competition in Price and Availability When Availability is Unobservable

“…These papers include Schwartz (1966 and1970), Balcer (1980), Fergani (1976, and Robinson (1990). Conslik and Smallwood (1979) consider competition in the probability of a breakdown when firm quality choice is unobservable, a problem which is extremely similar to competition in service rates, however they also treat price and consumer behavior as exogenous.…”

The Capacity Aspect of Inventories

“…In order to ensure a certain customer service-rate, we may introduce inventory holding costs and stock-out costs for the inventory of individual families (compare Tinarelli [52] and Schwarz [47]). …”