Two Backorder Compensation Mechanisms in Inventory Systems with Impatient Customers

Jian Chen, Shuo Huang, Refael Hassin, Nan Zhang

Research output: Contribution to journalArticlepeer-review


We study a compensation mechanism design problem with customer-choice behavior in a continuous review setting where the production and demand processes are stochastic. When a stockout occurs, the firm controls backorders on the basis of certain compensation policies. Customers make decisions to maximize their utility, which is decreasing in the price, the waiting time, and the customer's impatience factor. We assume that the impatience factor is private information held by the customer only. Two compensation mechanisms are designed to control backorders, namely uniform compensation and priority auction with an admission price. Under uniform compensation, the firm offers the same discount to all customers, whereas under auction compensation, priority is granted according to the customers' bid prices. We obtain the optimal stockout price and base stock level under each mechanism, and analyze the properties of the respective optimal policies. Assuming linear waiting costs with uniformly distributed impatience factor, we find that the auction mechanism (1) maintains a lower base stock level and results in greater profit and (2) benefits customers with relatively lower or higher impatience factors, but customers with a medium impatience factor may be rendered worse off. We further show that both compensation mechanisms are suitable for products with a high unit profit, a high lost sales penalty cost, and a high holding cost.

Original languageEnglish
Pages (from-to)1640-1656
Number of pages17
JournalProduction and Operations Management
Issue number10
StatePublished - Oct 2015


  • Nash equilibrium
  • auction
  • compensation mechanism
  • make-to-stock
  • pricing
  • queuing
  • strategic customers


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