Inventory decisions for substitutable products with stock-dependent demand

We study a retailer’s inventory policy for two products. The products are substitutable and have inventory dependent demand, so a higher inventory level of a product increases its sales. We model the joint effect of demand stimulation and product substitution on inventory decisions by considering a single-period, stochastic demand setting. We provide the first order optimality conditions for the profit maximizing order quantities and interpret them using marginal analysis. We also consider two heuristic solutions that separately account for either demand stimulation or product substitution. Our numerical analysis reveals that the optimal policy by appropriately using sales information that quantifies substitution and demand stimulation can produce significantly higher profits. The profit benefits are lessened under certain circumstances, such as when the two products have similar critical fractile values, suggesting that in such instances the heuristics may be used effectively.