A New Mechanism to Manage Inventory Decisions Under Demand Uncertainty: Probabilistic Selling
Posted: 11 Feb 2011 Last revised: 9 May 2014
Date Written: February 8, 2011
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: Suggested Citation