Constant Salvage Value Models: A Source of Systematic Bias in Predicting the Value of Lead-Time Reduction
21 Pages Posted: 18 Jan 2013
Date Written: January 15, 2013
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
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