Imperfect demand estimation for new product production planning

TL;DR

This paper investigates how errors in estimating consumer demand for new products impact production planning, highlighting the importance of overestimating certain demand parameters to ensure better profit and service levels.

Contribution

It introduces an inventory model that accounts for demand influenced by price and advertising, analyzing the effects of parameter misspecification on profit and service levels.

Findings

Overestimating price effect is safer for profit and service levels.

Overestimating advertising effect is safer under service constraints.

Underestimating advertising effect is conservative for profit maximization.

Abstract

We are interested in the effect of consumer demand estimation error for new products in the context of production planning. An inventory model is proposed, whereby demand is influenced by price and advertising. The effect of parameter misspecification of the demand model is empirically examined in relation to profit and service level feasibility. Faced with an uncertain consumer reaction to price and advertising, we find that it is safer to overestimate rather than underestimate the effect of price on demand. Moreover, under a service level constraint it is safer to overestimate the effect of advertising, whereas for strict profit maximization, underestimating the effect of advertising is the conservative approach.