Balancing profitability and waste reduction: optimizing markdown policies for retail inventory

Retailers resort to short-term price reductions when dealing with overstock and combating food waste to stimulate demand for excess and close-to-expire inventory. Expiration-based pricing is one of the most common mitigation practices to reduce food waste in retail stores. It attracts price-sensitive customers, but may also influence the purchasing decision of consumers who prioritize a long shelf life. It is, therefore, essential to incorporate the actual customer behaviour in the markdown optimization. We determine optimal markdown policies by analyzing demand interactions and addressing the nonlinear dependencies between demand effects. To achieve this, we develop a simulation model that captures customers' sequential arrival, the dynamic evolution of inventory over time, and the freshness levels of the inventories. We conducted several experiments that considered different customer behaviour patterns. We show that the efficiency of markdown policies mainly depends on the customer probability of a Last-Expired-First-Out (LEFO) withdrawal. Results show that discounts are particularly worthwhile for products where customers prefer fresh products and withdraw them according to the last-expired-first-out principle. While small discounts can already reduce food waste by up to 80%, the impact on profit mainly depends on the LEFO withdrawal.