Newsvendor decisions under supply uncertainty

Abstract

We analyse the impact of supply uncertainty on newsvendor decisions. First, we derive a solution for a newsvendor facing stochastic supply yield, in addition to stochastic demand. While earlier research has considered independent uncertainties, we derive the optimal order quantity for interdependent demand and supply and provide a closed-form solution for a specific copula-based dependence structure. This allows us to give insights into how dependence impacts the newsvendor’s decision, profit and risk level. In addition to the theory, we present experimental results that show how difficult newsvendor decisions under supply uncertainty are for human subjects. In our experiment, the control group replicated a well-known newsvendor experiment, whereas the test group faced additional supply yield uncertainty. Comparison of these results shows that under low-profit condition, subjects are able to incorporate supply uncertainty quite well in their decisions. Under high-profit condition, the deviation from the optimum is much more significant. We discuss this asymmetry and also propose some ways to improve newsvendor decision-making.

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