Yossi Aviv

Kathleen Thomas
December 2014

Fashion Product Sourcing at Sababi-Babi – The -Zulu Line

The Sababi-Babi company (SB hereafter) was established in late 2012 as an online retailer of fashion
products. The company’s core strategy leans on several key strengths. The first strength is the company’s
ability to identify exciting and unique fashion-like products. The second strength is the procurement
department’s ability to coordinate the production of these products. The third strength is SB’s excellent
connections with liquidators and store chains to which the company can sell remaining inventory. The
latter strength is vital in light of SB’s policy to hold products for only a limited period of time. Overall,
the above strengths allow SB to maintain its reputation as a connoisseur of fashion. The exercise below
represents a typical (and critical) decision process made by SB for almost all product lines.

The -Zulu Line

In early April 2014, SB identified an innovative line of 26 products named Alpha-Zulu (α-Zulu). An
assessment team was immediately instructed to investigate the promise behind such product offering,
including production implications and other related issues. Once this line was approved, a planning team
determined a two-month time frame in which this product line would be sold, and also forecasted
demand. By June, the planning team had prepared the following inputs for the production model.
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On the table above, the planning committee listed:

(i) Cost Per Unit -- the variable cost of bringing a unit of a product to stock.
(ii) Sales Price -- the net sales price per unit after accounting for delivery charges, etc.
(iii) Liquidation Price -- the net amount of money that can be recovered from any unit unsold at the end
of the sales period (e.g., through liquidation).
(iv) Demand Forecast.
(v) Range (+/-) – the range within which demand is expected to fall based on the demand forecast. For
instance, for product Bravo, the demand will be uniformly distributed in the range of 5,300 - 2,703
= 2,597 and 5,300 + 2,703 = 8,003.

For simplicity, assume demand for the products are not statistically correlated.

The Payoff Criterion

SB utilizes an expected payoff maximization model in its procurement decision making process. In this
model, SB will need to account for the cost of procurement and prospective revenues. The cost of
procurement includes variable costs only, and should not include any fixed costs. In regards to
prospective revenue, SB will need to consider revenues generated from both sales and liquidation. In
addition to these considerations, SB has established a “cost of capital” of 8% for a sales season. This cost
of capital is applied upfront to all procurement costs. Utilizing this approach enables SB to effectively
prioritize different lines of products-- after all, α-Zulu is not the only line of product to be offered.

For example, suppose that you decide to order 4,000 units of Bravo, and the realized demand is 3,560
units. SB’s payoff for this particular product would be:

Payoff = – 4,000 * $35 * (1 + 8%) + 3,560 * $42.35 + (4,000 - 3,560) * $12.71

At the moment, SB limits the procurement cost (excluding the 8%) to $3.5M for the -Zulu line.

Assignment
1. Suppose the forecasts are completely accurate (ignore the ranges in the table). What are the optimal
order quantities for the 26 products? With these quantities, what is SB’s expected payoff?
2. Again, ignore the demand ranges in the table. If SB increases the procurement limit from $3.5M to
$4.5M, would this increase be worthwhile to the company? If yes, by how much would SB’s expected
payoff increase?
Next, let’s bring back the demand uncertainties.
3. Using the order quantities determined in question 1 (based on the $3.5M procurement limit), what is
SB’s expected payoff? Provide a confidence interval for this figure. What is the likelihood that SB’s
payoff will be negative? Provide a confidence interval for this figure.

4. Given that SB is attempting to maximize expected payoff, propose a method to determine the order
quantities. Specifically, how many units of each of the 26 products should SB order? Estimate SB’s
expected payoff if they follow your solution method. Describe the rationale behind your solution, and
explain your analysis in a clear and logical fashion.
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5. Estimate SB’s expected payoff under perfect information (EPPI). Explain your analysis clearly.
6. Suppose that the supplier for the α-Zulu product line allows you to pay for the products at the end of
the sales season. As a result, the 8% cost of capital will not be applied, and the limit on the
procurement expenditure is eliminated. How would this change your answer to question 4?