Constant Salvage Value Models: A Source of Systematic Bias in Predicting the Value of Lead-Time Reduction

21 Pages Posted: 18 Jan 2013

See all articles by Stefan Wager

Stefan Wager

Stanford University - Department of Statistics

Suzanne de Treville

University of Lausanne - Faculty of Business and Economics; Swiss Finance Institute

Date Written: January 15, 2013

Abstract

The assumption that unsold goods can be liquidated at a constant salvage value is widespread in inventory theory. We show that, under general mathematical conditions, this modeling assumption will cause companies to underestimate both the value of lead-time reduction and the cost of lead time increases. Our result does not require that companies actively consider the possibility of non-constant salvage values. Rather we show that, in an environment where salvage values are allowed to depend on the amount of overage, a firm that cuts lead times according to a strategy that assumes a constant salvage value will earn more money than predicted from its lead-time reduction.

Keywords: Lead Time, Newsvendor Model, Martingale Model of Forecast Evolution, Salvage Value

Suggested Citation

Wager, Stefan and de Treville, Suzanne, Constant Salvage Value Models: A Source of Systematic Bias in Predicting the Value of Lead-Time Reduction (January 15, 2013). Available at SSRN: https://ssrn.com/abstract=2202422 or http://dx.doi.org/10.2139/ssrn.2202422

Stefan Wager (Contact Author)

Stanford University - Department of Statistics ( email )

Stanford, CA 94305
United States

Suzanne De Treville

University of Lausanne - Faculty of Business and Economics ( email )

AnthropĂ´le 3073
Lausanne, 1015
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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