The Newsvendor Problem in a Global Market: Optimal Centralized and Decentralized Control Policies for a Two-Market Stochastic Inventory System

Abstract

The global markets of today offer to the "style goods" producer more selling opportunities and pose new challenges in production planning and coordination. From a production management standpoint the opportunity to exploit the difference in timing of the selling season of geographically dispersed markets for "style goods" is important for improving the firm's profitability. In this paper we examine the above issue with an insightful model of a producer of "style goods" selling the goods to two markets (a primary and a secondary market) with nonoverlapping selling seasons. We refer to this problem as the "global newsvendor" problem. For the above two market stochastic inventory systems we first develop optimal centralized control policies. Then we demonstrate the suboptimality of decentralized production control policies, with the production centers at each market treated as independent profit centers and a constant transfer price being used to coordinate their production. We propose as an effective alternative a decentralized production control structure with a nonlinear pricing scheme for production coordination among centers administered through an intermediate organizational unit. In our modeling, we explicitly consider the effects of exchange rate uncertainty on the production planning decisions.supply chain management, international operations management, inventory management

Commissioned Paper: Capacity Management, Investment, and Hedging: Review and Recent Developments

“…In a newsvendor setting, managers in the first stage receive the expected shadow price, whereas later agents are charged the realized shadow price of the resources they utilize. This linear transfer-pricing system simplifies the nonlinear incentive scheme that coordinates the "global newsvendor" of Kouvelis and Gutierrez (1997), where two agents sell an identical product in two markets.…”

“…For example, while a firm may hedge currency risk with forward contracts, a firm that has production locations in two countries may be able to ex-post shift production to the preferential country, as analyzed by Huchzermeier and Cohen (1996). Similar benefits accrue to the "global newsvendor" of Kouvelis and Gutierrez (1997) with one production location but an ex-post transshipment option between countries. Clearly, such operational hedging may involve additional costs.…”

Logistics and Transportation in Global Supply Chains: Review, Critique, and Prospects

“…Kouvelis and Gutierrez [40] (1997) incorporate transfer prices and exchange rates into their two-market global newsvendor problem, obtaining the optimal quantities of items to ship from the primary market to the secondary market and the production quantities to be produced by the secondary market. The decisions to be made are from the viewpoint of the corporate planner, who must consider shortage costs attributed to lost sales and overage costs attributed to selling items at their salvage value at the end of their selling season.…”

“…Kouvelis and Gutierrez [40] also examine a decentralized policy, where each division of the firm is responsible for making purchasing and production decisions. This arrangement allows the divisions to act independently but requires more coordination in deciding the transfer prices applied to goods shipped between divisions.…”

“…This arrangement allows the divisions to act independently but requires more coordination in deciding the transfer prices applied to goods shipped between divisions. In cases where transfer prices are constant across the firm, this could lead to suboptimal policies, so the authors suggest that "more sophisticated transfer pricing mechanisms" be used (Kouvelis and Gutierrez [40] 1997). These mechanisms include firm-controlled transfer prices, when a constant and agreed-upon price is applied to shipments between profit centers, and intermediate purchasing coordination.…”