Management Insights

A merchant holding a fixed inventory of a perishable good is better off (at least in the short run) discounting his stock than allowing it to perish. This is true whether the item being sold is physically perishable, needs to be removed from the store by certain “out date,” or a service that uses fixed capacity. The decision to sell inventory at a discount changes the future expectations of customers and hence their buying behavior. The merchants who consistently use markdown policies risk training customers to “wait for the sale.” Contrary to the common belief, it is often optimal for the seller to limit second-period sales. The behavior of the optimal sales limit depends in part on the speed of customer updating. If customers update their expectations quickly, then the optimal sales limit can oscillate. If updating occurs more slowly, then the optimal sales limit tends to converge to a constant value that is strictly less than the capacity. Sellers who assume that demand is independent of past policies may overestimate customer demand at the full price and end up with substantially lower profits.