Inventory Management and Endogenous Demand: The Role of Customer Referrals, Defections, and Bankruptcy

26 Pages Posted: 16 Jun 2013 Last revised: 30 Jul 2013

See all articles by Oleg Sokolinskiy

Oleg Sokolinskiy

Board of Governors of the Federal Reserve System

Ben J. Sopranzetti

Rutgers Business School: Newark and New Brunswick

Date Written: July 29, 2013

Abstract

Working within the framework of a finite population, dynamic inventory optimization model where future demand is endogenous to inventory policy, this paper considers the effect of customer referrals and forced exit from the market caused by the loss of market share due to customer defections. Satisfied customers not only remain with the firm, but may also refer new customers, and, thus, increase expected future demand. In contrast, backorders, with some probability, and lost sales, with certainty, will cause disappointed customers to become disgruntled and leave the firm’s customer pool, which will result a lower market share and a fall in expected future demand. If the firm is unable to maintain its presence in the market, it is forced to leave the market for good, which is tantamount to bankruptcy. The incorporation of these innovations yields inventory policies that prescribe more aggressive replenishments relative to traditional base-stock policies, especially when the has low to medium market share. In product markets where customers can easily review the firm’s performance, e.g. on-line or on public forums, or have the freedom to take their business elsewhere, backorders and lost sales may be extremely costly. Consequently, the recognition of the endogeneity of future demand and its potential impact on the solvency of the firm is of special significance in the choice of optimal inventory policy.

Keywords: Inventory Management, Stochastic Endogenous Demand, Backorders, Lost Sales, Optimization, Profit Maximization, Market Share, Customer Satisfaction

JEL Classification: L81, M1, M3, M11

Suggested Citation

Sokolinskiy, Oleg and Sopranzetti, Ben J., Inventory Management and Endogenous Demand: The Role of Customer Referrals, Defections, and Bankruptcy (July 29, 2013). Available at SSRN: https://ssrn.com/abstract=2279540 or http://dx.doi.org/10.2139/ssrn.2279540

Oleg Sokolinskiy (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Ben J. Sopranzetti

Rutgers Business School: Newark and New Brunswick ( email )

100 Rockafeller Rd
Piscataway, NJ 08854
United States

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