Newsvendor Networks: Resource Flexibility, Sharing, and Hedging
Paper (PDF 1,276 K / 34 pages)
March 2004 (revised January 2006)
studies how differences in risk exposure and risk attitude
affect network configuration. Theory is presented for general
utility functions and their mean-variance approximations and
illustrated with networks featuring inventory substitution
and commonality, or resource sharing and flexibility.
with increased risk exposure, risk-neutral newsvendors change
resource levels proportionally to standard deviations, but
risk-averse agents adjust proportionally to variance. While
single-resource risk-averse newsvendors always invest less
than risk-neutral newsvendors, they may invest more in networks.
Not only may some resource levels increase in risk aversion,
even the entire monetary network investment may exceed its
risk-neutral counterpart. Two drivers explain this operational
hedge, suggesting rules of thumb for strategic placement of
safety capactiy and inventory in networks. With strongly negative
correlations, diversification (risk pooling) suggests to increase
inexpensive resources that supply lower profit variance products.
This highlights the role of profit over demand variance in
risk-averse network design. With product profit difference,
revenue maximization suggests to increase (decrease) parallel
(serial) flexibility. These insights confirm and refine the
intuitive notion of safety capacity/inventory and flexibility
as an operational hedge to mitigate risk.
to working paper series page