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Technical Note—A Risk-Sensitive Model for Managing Perishable Products

Department of Systems Engineering and Engineering Management, The Chinese University of Hong Kong, Shatin, NT, Hong Kong
Department of Management, Long Island University, C.W. Post, Brookville, New York 11548, and School of Economics and Management, Southwest Jiaotong University, Chengdu, 610031, China
yyfeng{at}se.cuhk.edu.hk
bxiao{at}liu.edu

This article presents a risk-sensitive model for managing perishable products assuming the supplier is averse to the variation of revenues. While traditional risk-neutral revenue management models offer optimal strategies in the long run, they are exposed to the variation of revenue flows. If a short-term revenue target is a primary concern for the supplier, the risk-neutral assumption fails to provide the best policy needed. The proposed model uses an exponential function with a risk-sensitive parameter instead of the conventional risk-neutral objective. The risk parameter measures how the supplier is sensitive to the deviation of revenues. We show that the new objective function captures the supplier's risk behavior. We develop a recursive procedure for the optimal solution in closed form. The optimal policy has attractive properties such as nested active price set, monotonicity with respect to the remaining time and inventory, and threshold-type control. When the supplier is more sensitive to the uncertain revenue flows, the risk-sensitive model leads to more conservative pricing policies. Finally, we show that the risk-neutral model is a special case of the proposed framework.

Subject classifications: revenue management; risk sensitive; exponential utility.
History: Received May 2004; revision received March 2007; accepted June 2007.