Supply Chain Management

1
Supply Chain Management

• Lecture 22

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Outline

• Today
• Finish Chapter 12
• Sections 1, 2, 3
• Section 2 up to and including Example 12.2
• Thursday
• Homework 5 due before class
• Start with Chapter 14
• Sections 1, 2, 3, 4, 6, 7, 8, 9
• Section 6 buyback and revenue sharing contracts
  only
• Next week
• Guest speaker Paul Dodge
• SVP Supply Chain, ProBuild

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Guest Lecture

• Date
• Tuesday April 13
• Speaker
• Paul Dodge (Senior Vice President Supply Chain)
• Subject
• Todays Supply Chain

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Semester Outline

• Tuesday April 6 Chap 12
• Thursday April 8 Chap 14
• Tuesday April 13 Paul Dodge guest lecture
• Thursday April 15 Chap 14, 15
• Tuesday April 20 Chap 15
• Thursday April 22 Simulation Game briefing
• Tuesday April 27 Review, buffer
• Thursday April 29 Simulation Game

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The Newsboy/Newsvendor Problem
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The Newsboy/Newsvendor Problem

• Order quantity (O)
• Uncertain demand (D)
• Cost of overstocking (Co c s)
• The loss incurred by a firm for each unsold unit
  at the end of the selling season
• Cost of understocking (Cu p c)
• The margin lost by a firm for each lost sale
  because there is no inventory on hand
• Includes the margin lost from current as well as
  future sales if the customer does not return

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ONeill PsychoFreak 3347

• The too much/too little problem
• Order too much and inventory is left over at the
  end of the season
• Order too little and sales are lost

Submit order to Manufacturer
Selling seaon
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Receive order from Manufacturer
Discount leftovers
8
ONeill PsychoFreak 3347

• Gather economic data
• Selling price (p 180)
• Procurement cost (c 110)
• Discount price (s 90)
• Forecast demand
• Empirical demand distribution
• Normal demand distribution
• Order quantity (so as to maximize profits)

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Example Parkas at L.L. Bean
What is the expected demand?
Expected demand ?Dipi 1,026 parkas
10
Example Parkas at L.L. Bean
What is the expected overstock?
What is the expected understock?
Expected understock ?Understockipi 111 parkas
Expected overstock ?Overstockipi 85 parkas
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Example Parkas at L.L. Bean
Cost c 45
Price p 100
Salvage value s 40
What is the expected profit?
Expected profit ?Profitipi 49,900
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Example Parkas at L.L. Bean
(1 CSL)(p c)
CSL(c s)
Cost of understockingp c 55
Cost of overstocking c s 5
What is the optimal order quantity?
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Example Parkas at L.L. Bean
(1 CSL)(p c)
CSL(c s)
What is the safety stock?
Safety stock Order quantity Expected Demand
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Optimal Level of Product Availability

• Expected marginal contribution of raising the
  order size from O to O1 (1 CSL)(p c)
  CSL(c s)

p c p s
Cu Cu Co
CSL Prob(Demand ? O)
O F-1(CSL, ?, ?) NORMINV(CSL, ?, ?)
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Example 12-1 Evaluating the optimal service
level for seasonal items

• The manager at Sportmart, a sporting goods store,
  has to decide on the number of skis to purchase
  for the winter season. Based on past demand data
  and weather forecasts for the year, management
  has forecast demand to be normally distributed,
  with a mean 350 and a standard deviation of 100.
  Each pair of skis costs 100 and retails for
  250. Any unsold skis at the end of the season
  are disposed of for 85. Assume that it costs 5
  to hold a pair of skis in inventory for the
  season. How many skis should the manager order to
  maximize expected profits?

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Example 12-1 Evaluating the optimal service
level for seasonal items
Average demand (mean) ?
Standard deviation of demand (stdev) ?
Material cost c
Price p
Salvage value s
Cost of understocking Cu
Cost of overstocking Co
Optimal cycle service level CSL
Optimal order size O
350
100
100
250
85 5 80
p c 250 100 150
c s 100 80 20
Cu/(Cu Co) 150/170 0.88
NORMINV(CSL, ?, ?) 468
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When Demand is Normally Distributed

• Expected profits (p s)?Fs((O ?)/?) (p
  s)?fs((O ?)/?) O(c s)F(O, ?, ?) O(p
  c)1 F(O, ?, ?)Expected overstock (O
  ?)Fs((O ?)/?) ?fs((O ?)/?)
• Expected understock (? O)1 Fs((O
  ?)/?) ?fs((O ?)/?)

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Example 12-1 Evaluating the optimal service
level for seasonal items

• Expected profits (p s)?Fs((O ?)/?) (p
  s)?fs((O ?)/?) O(c s)F(O, ?, ?) O(p
  c)(1 F(O, ?, ?))59,500NORMDIST(1.18,0,1,1)
  17,000NORMDIST(1.18,0,1,0) 9,360NORMDIST(468,
  350,100,1) 70,200(1 NORMDIST(468,350,100,
  1)) 49,146
• Expected overstock (O ?)Fs((O ?)/?)
  ?fs((O ?)/?) (450 350)NORMDIST((450
  350)/100,0,1,1) 100NORMDIST((450
  350)/100,0,1,0) 108
• Expected understock (? O)1 Fs((O ?)/?)
  ?fs((O ?)/?) (350 450)1
  NORMDIST(((450 350)/100,0,1,1)
  100NORMDIST((450 350)/100,0,1,0) 8

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Factors Affecting the Optimal Level of Product
Availability
Consider two products with the same margin. Any
leftover units of one product are worthless.
Leftover units of the other product can be sold
to outlet stores. Which product should have a
higher level of product availability?
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Intermezzo
CSL
1
Higher salvage value leads to lower Co
0
Co/Cu
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Factors Affecting the Optimal Level of Product
Availability
Consider two products with the same margin. Any
leftover units of one product are worthless.
Leftover units of the other product can be sold
to outlet stores. Which product should have a
higher level of product availability?
Consider two products with the same cost but
different margins. Which product should have a
higher level of product availability?
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Intermezzo
CSL
1
Nordstrom
Discount store
0
Co/Cu
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Maximizing Expected Profits

• Cost of over- and understocking have a direct
  impact on both the optimal cycle service level
  and profitability

How could one improve profitability?
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Improving Supply Chain Profitability

• Two obvious ways to improve profitability
• Increase salvage value of each unit
• Sport Obermeyer sells winter clothing in south
  America during the summer.
• Buyback contracts with manufacturer
• Decrease the margin lost from a stock out
• Arrange for backup sourcing or provide substitute
  product
• Car part suppliers, McMaster-Carr and
  W.W.Grainger, are competitors but they buy from
  each other to satisfy the customer demand during
  a stockout

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Improving Supply Chain Profitability

• Another way to improve profitability
• Reduce demand uncertainty
• Improved forecasting Use better market
  intelligence and collaboration to reduce demand
  uncertainty
• Quick response Reduce replenishment lead time so
  that multiple orders may be placed in a selling
  season
• Postponement In a multiproduct setting, postpone
  product differentiation until closer to point of
  sale
• Tailored sourcing Use a low lead time, but
  perhaps an expansive supplier as a backup for a
  low-cost, but perhaps long lead time supplier

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Example Impact of Improved Forecasting

• Demand is Normally distributed with a mean of ?
  350 and standard deviation of ? 150
• Purchase price c 100
• Retail price p 250
• Salvage value s 80

How many units should be ordered as ? changes?
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Example Impact of Improved Forecasting
Increase in forecast accuracy increases a firms
profits
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Impact of Improved Forecasting

• Better forecasts leads to reduced uncertainty
• Decreases both the overstocked and understocked
  quantity
• Increases a firms profits

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Impact of Quick Response

• Quick response is a set of actions a supply chain
  takes to reduce replenishment lead time

Lead time30 weeks
Selling season14 weeks
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Impact of Quick Response

• If quick response (reduction in replenishment
  lead time) allows multiple orders in the season
• A buyer can usually improve forecast accuracy
  after observing demand
• Less overstock, less understock
• Higher profits

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Example Impact of Quick Response

• Mattel was hurt last year by inventory cutbacks
  at Toys R Us, and officials are also eager to
  avoid a repeat of the 1998 Thanksgiving weekend.
  Mattel had expected to ship a lot of merchandise
  after the weekend, but retailers, wary of excess
  inventory, stopped ordering from Mattel. That led
  the company to report a 500 million sales
  shortfall in the last weeks of the year ... For
  the crucial holiday selling season this year,
  Mattel said it will require retailers to place
  their full orders before Thanksgiving. And, for
  the first time, the company will no longer take
  reorders in December, Ms. Barad said. This will
  enable Mattel to tailor production more closely
  to demand and avoid building inventory for orders
  that don't come.

Wall Street Journal, Feb. 18, 1999
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Mattel Inc. Toys R Us

• Decreasing replenishment lead times requires
  tremendous effort from the manufacturer, yet
  seems to benefit the retailer at the expense of
  the manufacturer
• Hence, the benefits resulting from quick response
  should be shared appropriately across the supply
  chain

Did Mattels action help or hurt profitability at
Toys R Us?
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Impact of Postponement

• Postponement is delaying product differentiation
  (customization) until closer to the time of the
  sale of the product
• Delaying the commitment of the work-in-process
  inventory to a particular product
• Examples
• Dell delivers customized PC in a few days after
  customer order
• HP printer places power supply modules, labels in
  appropriate language on to printers after the
  demand is observed
• Motorola cell phones are customized for different
  service providers after demand is materialized
• McDonalds assembles meal menus after customer
  order

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Example Impact of Postponement

• Benetton sells knit sweaters in four colors at a
  retail price p 50
• Option 1 (Long lead time) Dye the threat then
  knit the garment. Results in manufacturing cost c
  20.
• Option 2 (Short lead time). Knit the garment
  then dye the garment. Results in manufacturing
  cost c 22
• Benetton disposes any unsold sweaters at the end
  of the season in clearance for s 10.
• For each color 20 weeks in advance demand
  forecast
• Normally distributed with a mean of ? 1000 and
  a standard deviation of ? 500

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Example Impact of Postponement
? 1000, ? 500
? 4000, ? 1000
p 50c 20s 10 CSL (p c)/(c s) O
NORMINV(CSL,?,?)
p 50c 22s 10 CSL (p c)/(c s) O
NORMINV(CSL,?,?)
CSL 0.75 O 1,3374 5,348
CSL 0.70 O 4,524
Expected profits94,576
Expected profits98,092
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Tailored Postponement

• By postponing all garment types, production cost
  of each product goes up
• When this increase is substantial or a single
  products demand dominates all others (causing
  limited uncertainty reduction via aggregation), a
  partial postponement scheme is preferable to full
  postponement.
• Tailored postponement allows a firm to increase
  profits by postponing differentiation only for
  products with the most uncertain demand products
  with more predictable demand are produced at
  lower cost without postponement

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Tailored (Dual) Sourcing

• Tailored sourcing is a business strategy where a
  firm uses a combination of two supply sources
• The two sources must focus on different
  capabilities