What Can Be Learned from Classical

Inventory
Models? A Cross-Industry Exploratory
Investigation (2007)
Sergey Rumyantsev and Serguei Netessine

1. Introduction
Classical inventory models:
- assume exogenous and usually static business
environments, and rational agents -> normative in
nature;
- derived at the product level and not the firm level
(microscopic level -> firm as a black box);
- often do not account for many practical
considerations;
Can insights from these models be used to

1. Introduction
Macroeconomics:
- looks at firms outside the black box, by analyzing aggregate
behavior;
- no inside perspective -> not useful to describe internal inventory
drivers, e.g. lead times-inventory levels relationship.
Contribution 1: Check for consistency between the two perspectives,
and show that classical inventory theory conclusions are useful.
Contribution 2: Quantify the association between the environmental
variables and inventories at the firm level inventory level elasticity.

2. Literature Review
From simple models (EOQ) to advanced inventory models
that incorporate stochastic and correlated demands, multiple
products, and multiple echelons.
Pure operations research model is blind to data issues
(Wagner, 2002).
Malhorta et al. (2001), Chen et al. (2005, 2007), Gaur et al.
(2005) provide empirical insights.
Lieberman et al. (1999) analyze inventory dynamics in
automotive industry.
Hendricks et al. (2005), Cachon et al. (2007) investigate at
the supply chain level.
Newsvendor inventory model: Cohen et al. (2003), Olivares et
al. (2004)

3. Formulation of Research
Hypotheses
Reasons for inventory:
- Production not at same time and place as demand
(lead times);
- rigid production capacity but variable demand;
- economies of scale in handling inventories;
- nonstationarity (seasonality, stochasticity) in demand
and/or supply.

3. Formulation of Research
Hypotheses
Two methodological challenges:
- what classical inventory theory insights will hold at
aggregate data level across time and space structural
properties will not, but monotone ones will;
- understand relationship between operational variables
throughout operations and decision-making: beginning
vs end of period.
Assumptions: rationality and stationary and
independent demand (+ proxies for behavioral aspects)

3. Formulation of Research
Hypotheses
H1: Aggregate inventory level is positively associated with

aggregate mean demand through a concave function. =

combination of linear (newsvendor) and square-root (EOQ)
functions.
H2: Aggregate relative inventory level (i.e., the ratio of inventory
to sales) is negatively associated with company size. =
economies of scale.
H3: Aggregate inventory level is positively associated with
aggregate demand uncertainty. = buffer.
H4: Aggregate inventory level is positively associated with
aggregate procurement lead times. = buffer.
H5: Aggregate inventory level is positively associated with
aggregate product margins. = underage.
H6: Aggregate inventory level is negatively associated with
aggregate inventory holding costs. = overage.

4. Data Description
quarterly (~seasonal fluctuations) data containing 44 time points
between 1992 and 2002 for 722 firms from the Compustat
financial database.
panel data
pooled and segment-specific estimations
data represents 30% of total US manufacturing and retailing
business inventory, strongly correlated with total US inventory.
financial accounting data crudely reflects actual processes within
companies.
data aggregated across product lines and production units. ->
product variety in the future.

5. Description of Variables

6. Model Specification