Newsvendor Networks: Inventory Management and Capacity Investment with Discretionary Activities
Manufacturing & Service Operations Management, Vol. 4, No. 4, Fall 2002, pp. 313-335
23 Pages Posted: 8 Feb 2013
Date Written: 2002
We introduce a class of models, called newsvendor networks, that generalizes the well-known newsvendor model along three dimensions. Newsvendor networks model the flow of multiple products through multiple processing and storage points over multiple time periods. Such models provide a parsimonious framework to study various problems of stochastic capacity investment and inventory procurement. Newsvendor networks can feature commonality, flexibility, substitution or transshipment in addition to assembly and distribution. Newsvendor networks are stochastic models with recourse that are characterized by linear revenue and cost structures and a linear input-output transformation. While capacity and inventory decisions are locked in before demand uncertainty is resolved as usual, some managerial discretion can remain via ex-post input-output activity decisions. This discretion is captured through non-basic activities that model input- or resource-substitution and that result in subtle pooling effects. Non-basic activities are never used in a deterministic environment; their value stems from the discre- tionary flexibility to meet stochastic demand deviations from the operating point. The optimal capacity and inventory decisions balance overages with underages. Continuing the classic newsvendor analogy, the optimal balancing conditions can be interpreted as specifying multiple "critical fractiles" of the multivariate demand distribution. This paper shows that the properties of optimal single-period newsvendor network solutions extend to a dynamic setting under plausible conditions. Indeed, we establishes dynamic optimality of inventory and capacity policies for the lost sales case. Depending on the non-basic activities, this also extends to the backordering case. Analytic and simulation-based solution techniques and graphical interpretations are presented and illustrated by a comprehensive example that features input substitution and a flexible processing resource.
Keywords: Inventory, Capacity, Assembly, Commonality, Distribution, Flexibility, Substitution, Transshipment, Multiple Products
Suggested Citation: Suggested Citation