Dynamic Pricing and Inventory Management with Regular and Expedited Supplies

Abstract

We consider a periodic‐review inventory system with regular and expedited supply modes. The expedited supply is faster than the regular supply but incurs a higher cost. Demand for the product in each period is random and sensitive to its selling price. The firm determines its order quantity from each supply in each period as well as its selling price to maximize the expected total discounted profit over a finite or an infinite planning horizon. We show that, in each period if it is optimal to order from both supplies, the optimal inventory policy is determined by two state‐independent thresholds, one for each supply mode, and a list price is set for the product; if only the regular supply is used, the optimal policy is a state‐dependent base‐stock policy, that is, the optimal base‐stock level depends on the starting inventory level, and the optimal selling price is a markdown price that decreases with the starting inventory level. We further study the operational impact of such supply diversification and show that it increases the firm's expected profit, reduces the optimal safety‐stock levels, and lowers the optimal selling price. Thus that diversification is beneficial to both the firm and its customers. Building upon these results, we conduct a numerical study to assess and compare the respective benefit of dynamic pricing and supply diversification.

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