The variable salvage value newsvendor model and its impact on supply contracts

Abstract

Clearance price depends on the leftover inventory in many real life contexts. The classical newsvendor model assumes a fixed salvage value for clearance sales. This assumption could lead to suboptimal order quantity and expected profit. We analytically prove that the newsvendor model with fixed salvage value results in over ordering and profit loss compared to a newsvendor model where salvage value is a function of leftover inventory. The conditions under which the variance in performance between the two newsvendor models is significant are determined. The paper also models, for variable salvage value, the wholesale price, buy-back, revenue sharing and sales rebate contracts for supply chain coordination. With regards to supply chain coordination, the variable salvage model displays similar behaviour as the fixed salvage model. Through numerical analysis we also illustrate the differences between the two salvage value models for the supply contracts considered.