Title: Impact of inventory cannibalisation on a retailer selling substitutes

Authors: Chirag Surti; Prakash Abad; Elkafi Hassini

Addresses: College of Business Administration, Rider University, 2083 Lawrenceville Rd, Lawrenceville, NJ 08648, USA ' DeGroote School of Business, McMaster University, 1280 Main St West, Hamilton, ON, L8S 4M4, Canada ' DeGroote School of Business, McMaster University, 1280 Main St West, Hamilton, ON, L8S 4M4, Canada

Abstract: The reasons customers substitute, are well understood from an economic perspective. However, its exact impact on retailer's inventory and profit is not, when customers substitute as a result of a shortage. Shortage of one product may lead to demand spillover, due to substitution, resulting in shortages for the second product. We call this inventory cannibalisation. This is a store level, retailer observed phenomenon that is a direct result of customers' willingness to switch between substitutes due to stockout of one product. Many retailers are experiencing stockouts related to substitution, resulting in a significant loss of revenue. We model a retailer's selling two substitutes, facing price-sensitive stochastic demand. Our model incorporates cannibalisation explicitly and generalises the existing literature on inventory substitution. We perform analytical and numerical analysis to study the impact of stockout-based substitution and the related inventory cannibalisation on retailer's decisions. We find that the impact of cannibalisation is felt most acutely by the retailer for products with low degree of substitution.

Keywords: pricing; stock outs; substitution; inventory management; inventory cannibalisation; retail operations.

DOI: 10.1504/IJOR.2018.095197

International Journal of Operational Research, 2018 Vol.33 No.2, pp.179 - 207

Received: 06 Mar 2015
Accepted: 03 Oct 2015
Published online: 02 Oct 2018 *

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