Risk-Adjusted Return on Inventory Buys

Retailers prefer to carry products that have both high expected demand and low demand uncertainty. Unfortunately, these are competing concerns, and so it's not always obvious which product to choose when one option has both higher expected demand and higher demand uncertainty.

Here, we present a simple formula for a product's risk-adjusted expected profit, using the newsvendor model. This score can be used to rank candidate products, allowing one to rationally balance the trade-off between expected demand and demand uncertainty. We cover a simple example and also share a Google Sheet that carries out the relevant computations, useful for both candidate product ranking and profit forecasting.

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