The Impact of a Target on Newsvendor Decisions
Posted: 8 Oct 2012
Date Written: September 12, 2012
In this paper we investigate the impact of a target on newsvendor decisions. Different to the existing approach that maximizes the probability of the profit reaching the target, in this paper we model the effect of a target by maximizing the satisficing measure of a newsvendor's profit with respect to that target. We study two satisficing measures: CVaR satisficing measure that evaluates the highest confidence level of CVaR achieving the target; and Entropic satisficing measure that assesses the smallest risk tolerance level under which the certainty equivalent for exponential utility function achieves the target. For both satisficing measures, we find that the optimal ordering quantity increases with the target level. Further, the newsvendor orders more than the risk-neutral solution (over-order) sometimes and less than that (under-order) other times, depending on the target level. The more interesting finding is that if the target is proportional to the unit marginal profit and is also determined by only one other demand-related factor, then the newsvendor over-orders low-profit product and under-orders high-profit product. This is consistent with the existing findings in newsvendor experiments, and suggests that our modelling framework may provide a potential explanation for the behavioral findings.
Keywords: newsvendor, risk measure, target profit
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