Managing Inventories of Perishable Goods: The Eﬀect of Substitution Borga Deniz* • Alan Scheller-Wolf* • Itır Karaesmen** * The Tepper School of Business, Carnegie Mellon University, Pittsburgh, PA 15213, USA ** R.H. Smith School of Business, University of Maryland, College Park, MD 20742, USA bdeniz@andrew.cmu.edu • awolf@andrew.cmu.edu • itir@umd.edu October 30, 2004 We consider a discrete-time supply chain for perishable goods where there are separate demand streams for items of diﬀerent ages. We propose two practical replenishment policies: replenishing inventory according to order-up-to level policies based on either (i) total inventory in system or (ii) new items in stock. Given these policies, we concentrate on four diﬀerent ways of fulﬁlling demand: (1) demand for an item can only be satisﬁed by an item of that age (No-Substitution); (2) demand for new items can only be satisﬁed by new ones, but excess demand for old items can be satisﬁed by new (Downward-Substitution); (3) demand for old items can only be satisﬁed by old, but excess demand for new items can be satisﬁed by old (Upward-Substitution); (4) both downward and upward substitution are employed (Full-Substitution). We compare these substitution options analytically in terms of the inﬁnite horizon expected costs, providing conditions on cost parameters that determine when (if at all) one substitution option is more proﬁtable than the others, for an item with a two-period lifetime. We also prove that inventory is “fresher” whenever downward substitution is employed. Our results are based on sample-path analysis, and as such make no assumptions on demand. We complement our results with numerical experiments exploring the eﬀect of problem parameters on performance. Keywords: Perishable goods, Inventory management, Substitution, Stochastic models, Inﬁnite hori- zon, Sample path analysis.