Stockout Compensation: Joint Inventory and Price Optimization in Electronic Retailing

Abstract

Delays in product availability are common in e-commerce where electronic retailers try to manage with very low inventories. While this lowers inventory costs, the negative effect of increased stockouts is to reduce net demand for the product. We analyze the effect of offering a lower price during stockout to compensate for a customer’s waiting time, using an EOQ-type inventory-modeling framework but solving simultaneously for both the optimal prices and the lengths of the in-stock and stockout periods. The lower price recaptures some lost demand and has an important synergistic effect: the increased sales rate leads to lower unit costs for inventory holding and product ordering. Stockout compensation improves market efficiency and increases the retailer’s sales and profit. The optimal stockout-compensation policy is to choose period lengths and prices such that the two periods have equal effective prices (i.e., the optimal stockout compensation equals the average waiting cost for a customer). Compared with the pure wait-free and stockless-operation policies, stockout compensation not only yields greater profits, but also greater revenues, lower unit costs, and increased consumer surplus and market coverage. Compared with a backorder policy without compensation, the stockout compensation policy improves profits and social welfare but at the expense of consumer surplus. Allowing for strategic consumer behavior under knowledge of future prices, the equal-effective-prices solution defines a rational-expectations equilibrium.

On the Value of Commitment and Availability Guarantees When Selling to Strategic Consumers

“…See Dong and Rudi (2004), Dana (2000), and Bhargava, Sun and Xu (2006) for some anecdotal evidence of various forms of availability guarantees. Of course, the seller may also simply offer monetary compensation.…”

“…It is thus common practice in the catalog industry to offer financial compensation, such as price discounts or reduced shipping charges, to customers ordering out-of-stock items (Anderson, Fitzsimons and Simester, 2006). Similarly, some online retailers offer monetary incentives for customers to place a backorder on currently unavailable items (Breugelmans, Campo and Gijsbrechts, 2006;Bhargava, Sun and Xu, 2006). To the extent that this strategy is effective in sustaining consumer demand, some e-tailers have even moved to a "stockless" mode of operation, relying entirely on using discounts to compensate consumers for stockout related costs (Sun, Ryan and Shin, 2008).…”

A Decomposition Approach for a Class of Capacitated Serial Systems

“…This could lead to convex backordering costs. Please see Bhargava et al (2005) for several examples from the online retail industry that are similar in spirit.…”

Analyzing information-enabled stockout management under vendor-managed inventory

“…In return, the retailer agrees to allow the manufacturer to manage its inventory under a VMI arrangement. Our approach to providing incentives for improved stockout management is similar to Bhargava et al [3] in which they analyze the effect of offering a lower price when stocked out to compensate for a customer's waiting time in electronic retailing. In particular, we propose a contracting solution that addresses both retailer concerns about obtaining benefits under VMI and supplier concerns about reducing stockouts and increasing revenues under a VMI arrangement.…”