A method for estimating stock-out-based substitution rates by using point-of-sale data

Empirical studies in retailing suggest that stock-out rates are quite high in many product categories. Stock-outs result in demand spillover, or substitution, among items within a product category. Product assortment and inventory management decisions can be improved when the substitution rates are known. In this paper, a method is presented to estimate product substitution rates by using only Point-Of-Sale (POS) data. The approach clusters POS intervals into states where each state corresponds to a specific substitution scenario. Then available POS data for each state is consolidated and the substitution rates are estimated using the consolidated information. An extensive computational analysis of the proposed substitution rate estimation method is provided. The computational analysis and comparisons with an estimation method from the literature show that the proposed estimation method performs satisfactorily with limited information.