Technical Note - Multiproduct Inventory Management Under Customer Substitution and Capacity Restrictions

The presence of customer substitution poses substantial challenges to a firm’s inventory management, particularly so when the firm has to manage a multiproduct portfolio with capacity restrictions. In this paper, we derive the optimal inventory policy for a capacity-constrained firm selling multiple partially substitutable products over a finite season in a market with stockout-based customer substitution. We also establish the sensitivity of the optimal policy with respect to changes in capacity and substitution preferences. In doing so, we disentangle the direct and indirect dynamics of substitution, and show the nonmonotonic and partially counterintuitive influence of capacity and substitution on the firm’s optimal inventory policy.