Pricing Strategy Helps Manufacturers Decide When to “Scrap or Sell” Not Quite Perfect Products

Several production processes not only produce quality, high-end products but also generate what are known as Not-Quite-Perfect Products (NQPPs) that do not fully meet quality standards. Manufacturers then have a decision to make – get rid of all the NQPPs at a cost, known as scrapping, and only carry the high-end products or sell some or all of the NQPPs on a lower end marketing to value-conscious consumers. It’s often a challenging choice but new supply chain research has created a model that makes this business decision a bit easier.

In “Scrap or Sell: The Decision on Production Yield Loss,” Rong Li, assistant professor of supply chain management at Syracuse University’s Martin J. Whitman School of Management, and her co-authors, Yu Xia (William & Mary) and Xiaohang Yue (University of Wisconsin-Milwaukee, find that there is a point of diminishing returns when balancing supply of high-quality products with the lower quality ones.

Using data from semiconductor and other electronics industries, the researchers found that when production yield rates are high, manufacturers tend to turn scrapping costs into sales profits. But, in doing so, they sacrificed their primary markets with overproduction, thus decreasing overall profit.

“Often these NQPPs can be resold to other markets with a secondary use, such as a memory chip manufactured for PCs that can also be used in a toy,” explained Li. “Companies have to decide whether it’s worth it to sell these lower value products in a secondary market, or scrap them and keep making only high-end products, at a higher cost. These higher costs come from extra quality tests and other steps in the manufacturing process.

“The best strategy to deal with production yield loss depends on the yield rate, scrapping cost, market sizes and price differences,” Li continued. “And this is true no matter the industry. You could also apply our model to apparel or even food.”

For example, a company, such as Lands’ End, would be able to use the model to determine whether to get rid of clothing with defects, such as missing buttonholes, or sell the apparel in its outlet stores. Food distributors could make decisions on selling misshapen fruit at a lower cost (think ugly fruits!), or getting rid of them in some other manner.

The research is forthcoming in Production and Operations Management.