A New Mechanism to Manage Inventory Decisions Under Demand Uncertainty: Probabilistic Selling

Posted: 11 Feb 2011 Last revised: 9 May 2014

See all articles by Scott Fay

Scott Fay

Syracuse University

Jinhong Xie

University of Florida - Warrington College of Business Administration

Date Written: February 8, 2011

Abstract

Managing inventories is difficult for a seller who faces uncertainty about future demand for its products. Unexpectedly low demand for a product leads to wasted investment in inventory and subsequent markdowns. Conversely, unexpectedly high demand leads to stockouts and the resulting opportunity cost of foregone sales. In this paper, we consider how these tradeoffs are balanced when a seller engages in probabilistic selling (PS), a recently developed innovative selling strategy. We find that PS can be an effective mechanism to improve inventory utilization because offering consumers a choice of buying a probabilistic good reduces the variation in realized demand across products. We identify conditions under which PS enhances profit by encouraging a seller to either reduce or increase the size of its initial inventory order (relative to the case when probabilistic products are not offered). Furthermore, we show that integrating the inventory decision and PS can improve market efficiency.

Keywords: probabilistic selling, inventory decisions, demand uncertainty, capacity utilization

JEL Classification: M31, D21, D42, D61, L81

Suggested Citation

Fay, Scott and Xie, Jinhong, A New Mechanism to Manage Inventory Decisions Under Demand Uncertainty: Probabilistic Selling (February 8, 2011). Available at SSRN: https://ssrn.com/abstract=1757856 or http://dx.doi.org/10.2139/ssrn.1757856

Scott Fay (Contact Author)

Syracuse University ( email )

900 S. Crouse Avenue
Syracuse, NY 13244-2130
United States
315-443-3456 (Phone)

HOME PAGE: http://whitman.syr.edu/Directory/ShowInfo.aspx?id=360

Jinhong Xie

University of Florida - Warrington College of Business Administration ( email )

209 Bryan Hall Campus Box 117155
Gainesville, FL 32611-7166
United States
352-392-0161 Ext. 1233 (Phone)
352-846-0457 (Fax)

HOME PAGE: http://bear.cba.ufl.edu/xie/Xie_DirectoryProfile.htm

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