Optimal Ordering Policies for Style Goods

Generic Situation:

At the beginning of the season retailers must determine how many units to order of various goods. The problem is that the demand for these products is virtually unknown at the beginning of the season. After a few weeks, however, the retailer has a fairly good idea of what products are “hits” and which are “misses” and can place another order (at higher cost) for the “hits”. The goal is to order those various products in those quantities that result in the greatest profit.

Example:

Mr. Leslie is the head buyer for Global Sweaters Inc. Suppose that it costs Global $9 to order a sweater now. If an order is placed in four weeks, a fixed ordering cost of $300 is incurred, along with a cost of $10 per sweater order. Sweaters are sold for $20. At the end of the season sweaters may be sold for $4 (“salvage price”). Mr. Leslie has estimated that this season Weeks 1-4 sales will equal 200. Mr. Leslie wants an ordering policy that will maximize expected profit.

Profit Maximizing Solution:

Order 872 sweaters now. After observing demand for Weeks 1-4, a reorder is put in if the estimate is 110 sweaters or more are needed for the rest of the season.