The impact of stockout-based switching on fill rates

The possibility of product substitution due to a stockout provides retailers with a buffer against lost sales but can also complicate the management of inventory because both substitute and primary demand affect inventory levels. Since most retailers make their inventory decisions around a desired service level (e.g., fill rate), it is important to understand how customer substitution behavior can influence different measures of customer service. In this study, an extensive theoretical framework is presented and used to develop a decision tree approach for predicting realized item and category fill rates. We find that item fill rate is primarily a function of the target service level of the focal item and the willingness to switch from an alternate item to the focal item. Category fill rate is influenced by the target service level of both items, with willingness to switch amplifying their effect. The decision tree approach is found to be an accurate predictor in most cases, however, it tends to overestimate item fill rate when the willingness to substitute from the alternate item increases. The approach also accurately predicts category fill rates, outside of scenarios with asymmetric substitutability.