Production and stock management under manufacturer and customer driven substitution

Töre, Nurşen
In this thesis, the stock management problem of a manufacturer is studied in the presence of product substitution flexibility. The study consists of two parts. In the first part, the manufacturer's joint production scheduling and product substitution decisions are analyzed. It is assumed that there are multiple substitutable items and for each item, and inventory is kept separately. If upon demand arrival, stock is not available, then demand is backordered. Depending on the inventory level, it is possible to meet the demand via a substitute item. However, it takes a time and cost to substitute the item with another one. The production and substitution decisions are given dynamically over time depending on the net inventory level of the products. It is shown that for the two-product setting optimal production policy is characterized by a hedging point and a switching curve, and the substitution policies are characterized by threshold substitution levels. For the two-product setting the benefit of substitution, and the value of stock level information are quantified. For the multiple item setting, several heuristics are proposed. Through numerical analysis, the conditions under which each heuristic performs well are identified. In the second part of the thesis, the manufacturer's response to substitution behavior of the customer is studied. The manufacturer can manipulate the customer's substitution behaviour by price and availability of the products. The manufacturer decides on the optimal stock levels, the initial price of the products, and the market markdown price after the demand is realized. It is assumed there are two substitutable products and for each item, initial stock levels are determined separately. Since the products the manufacturer produces are similar, uniform pricing is used. Then according to price determined by the manufacturer, random demands for products occur. After the initial selling period, price is updated, that results in customer demand shift to the other product. The customer's initial demand and the demand spill-over due to price and stock-out based substitution are characterized through the Representative Consumer Theorem framework. We adopt a two-phase solution methodology where in the first we determine the optimal price after the demand realization, and then determine the initial price and stock levels. While doing so we gain an understanding on how the manufacturer should determine the optimal prices. To determine the initial price and the stock levels, we offer a solution approach for finding the KKT points of the corresponding model. Through numerical analysis, we obtain insights on how stock levels are determined, how the price decisions and the profit respond to the substitution behavior of the customers. Finally, through numerical analysis we quantify the value of exploiting the stockout based substitution via markdown pricing, and the value of the optimal solution.
Citation Formats
N. Töre, “Production and stock management under manufacturer and customer driven substitution,” Ph.D. - Doctoral Program, Middle East Technical University, 2014.