A New Approach to Stockout Penalties

Benjamin L. Schwartz
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Benjamin L. Schwartz: Institute for Defense Analyses

Management Science, 1966, vol. 12, issue 12, B538-B544

Abstract: Classical inventory theory considers that stockouts generate penalty costs to the firm, often assumed to be proportional to the excess of demand over supply. While such a concept is sometimes appropriate, it does not correctly reflect the effect of loss of goodwill. The latter is characterized by the fact that a disappointed customer reacts in the future to change his purchasing habits. Thus the nature of the effect is that subsequent demand is perturbed, a phenomenon quite different from having an immediate penalty cost imposed. Models with this property are termed perturbed demand, abbreviated PD. In this paper, this concept is defined precisely, and some of its properties are developed. Some typical cases are solved to determine optimal policies when PD prevails.

Date: 1966
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