Supply Chain Management

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Supply Chain Management

• Lecture 21

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Outline

• Homework 6
• Due Thursday November 12 before class
• Thursday
• Chapter 14
• Sections 1, 2, 3, 4, 6, 7, 8, 9
• Today
• Homework 6 hints
• Sections finish Chapter 12
• Sections 1, 2, 3
• Section 12.2 up to and including Example 12-1

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Detailed Outline

• Tuesday November 10 Chap 12
• Thursday November 12 Chap 14
• Tuesday November 17 Paul Dodge guest lecture
• Thursday November 19 Chap 14, 15
• Tuesday December 1 Chap 15
• Thursday December 3 Simulation Game briefing
• Tuesday December 8 Chap 15, review
• Thursday December 10 Simulation Game

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Homework 6 Hints

• Weekly demand for HP printers at a Sams Club
  store is normally distributed, with a mean of 250
  and a standard deviation of 150. The store
  manager continuously monitors inventory and
  currently orders 1,000 printers each time the
  inventory drops below 600 printers. HP currently
  takes two weeks to fill an order

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Homework 6 Hints

• How much safety inventory does the store carry?

Inventory
Lot size
Reorder point
Demand during lead time
Safety Inventory
0
Time
Lead time
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Homework 6 Hints

• What CSL does Sams Club achieve as a results of
  this policy?

Inventory
CSL Prob(DL ? ROP)
CSL F(ROP,DL,?L)
Reorder point
Demand during lead time
0
Time
Lead time
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Homework 6 Hints

• What CSL does Sams Club achieve as a results of
  this policy?

CSL Prob(DL ? ROP)
CSL F(ROP,DL,?L)
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The Newsboy/Newsvendor Problem
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Factors Affecting the Newsboy/Newsvendor Problem

• 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 (Cu
  p c g)
• Order quantity (O)

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How Much to Order?
Cost(D, O)
CuD Co(O D) if D ? O
Profit(D, O)
CuO if D gt O
Expected profit of ordering extra unit CuP(D gt
O) CoP(D ? O)
0 CuP(D gt O) CoP(D ? O)
0 Cu(1 CSL) CoCSL
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Parkas at L.L. Bean
p 100
c 45
s 40
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How Much to Order?

• Order extra unit if it increases expected profits

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
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 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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Factors Affecting the Optimal Level of Product
Availability
Consider two products with the same cost but
different margins. Which product should have a
higher 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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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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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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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
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Example Impact of Improved Forecasting
Increase in forecast accuracy 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

• Impact of quick response (reduction in
  replenishment lead time)
• Typical example of quick response is multiple
  orders in one season for retail items (such as
  fashion clothing)
• A buyer can usually improve forecast accuracy
  after observing demand
• Benefits
• Lower order quantities ? less inventory, same
  product availability
• Less overstock, less understock
• Higher profits

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Mattel Inc. Toys R Us

• 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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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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Why Postponement?

• Not providing product differentiation leads to
  market loss
• Postponement delays product differentiation until
  closer to the time of sale of the product
• All activities prior to product differentiation
  require aggregate forecasts which are more
  accurate than individual product forecasts
• Lee and Billington (1994) reports 400 forecast
  errors for high technology products
• With postponement individual product forecasts
  are needed closer to the time of sale, resulting
  in a better match of supply and demand and thus
  higher profits
• Saves Inventory holding cost by reducing safety
  stock
• Inventory pooling

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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
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

• A firm uses a combination of two supply sources
• One with lower cost that is unable to deal with
  demand uncertainty
• One with higher cost, which is flexible and able
  to deal with uncertainty
• The two sources must focus on different
  capabilities

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Tailored (Dual) Sourcing

• Tailored sourcing is a business strategy where a
  firm uses a combination of two supply sources

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Summary

• Optimal order quantities are obtained by trading
  off cost of lost sales and cost of excess stock
• Levers for improving profitability
• Increase salvage value and decrease cost of
  stockout
• Improved forecasting
• Quick response with multiple orders
• Postponement
• Tailored sourcing