The Newsvendor Model in SCM

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Many supply chain management (SCM) approaches can be explained using the Newsvendor Model (NVM). This model, which originally comes from inventory management, evaluates both the costs of excessively high inventories and the costs of excessively low inventories and, through mathematical-statistical analysis, arrives at a – model-like – profit-maximum inventory. This optimal inventory can be calculated or simulated for an entire supply network.

What are stocks in the SCM?

In a supply and service network, the term “inventories” must be defined much more broadly than just material inventories. Therefore the concept of stock is given a human reservoir of actions, i.e. a comprehensive stock of human options for action.

Requirements for the classic newsvendor model

The classical NVM has some restrictive requirements, which are explained in the following

  • Insecure demand situation (e.g. seasonal goods, innovative products and services)
  • One-period model (e.g. no subsequent deliveries possible during the sales period due to too long delivery times in relation to the sales period)
  • Selling prices are below the cost price, whereby the discounted inventory costs are also included in the cost price.

Under- and overstock costs are notsymmetrically distributed

Through numerous adaptations, the classic NVM can be successively introduced to the complex requirements of logistical reality and cause numerous firmly believed data in companies to falter. For example, the “optimal order quantities” that are believed to be reliable are only correct if the under- and overstocking costs are equally high and symmetrically distributed. However, this is only the case in exceptional cases. Thus, these calculations of – in part highly regarded ERP systems working with this assumption – are simply wrong and mislead employees and managers. Admittedly, vigilant dispatchers notice in practice that something may not be right! But if even quiet criticism of renowned ERP systems is considered blasphemous, the criticism from employees who work at the base is soon silenced.

Over- and understocking costs in the supply chain

Finally, the big challenge for SC managers is to calculate the over- and under-stocking costs for a mission-critical supply and service chain. The challenge for SCM here is to distribute the over-sumulative risk costs (under- and over-stocking costs of the entire success-critical supply chain) to the individual participants in such a way that the 3 basic requirements of any – successful – supply chain management are maintained. The supply chain must achieve added value in vertical cooperation, none of the participants in the supply chain must be placed in a worse position (Pareto efficiency) and finally the end consumer must have a better price/performance ratio. The newsvendor model is an essential tool to meet these high demands of the future.

For further information on supply chain management, please see “Logisticians of the future” – The Supply Chain Manager.

Image source: © Mike Licht, license: (CC BY 2.0)

About Ernst Kurzmann

Ernst Kurzmann

Ernst Kurzmann is a lecturer in the fields of internationalization, logistics and supply chain management. He also holds a Master of Business Administration (FIBAA accreditation) and has been a business trainer and consultant in Austria for decades, specializing in statistical and mathematical calculations in logistics & supply chain management. Ernst Kurzmann gained his professional experience at renowned companies such as Unilever, Alcatel or PepsiCo. He has been self-employed for 20 years and has published his specialist book "Supply Chain Management. How to survive in the 21st century with networked thinking", which has become a bestseller in this field, among others. His current publication "ManagemANT - What specialists and managers can learn from ants. With Swarm Intelligence towards Corporate Success" was published in August, by the Frankfurter Allgemeine Buch Verlag F.A.Z.

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