Suggested Solution to Assignment 2 Part 1

November 10, 2011

1. What are some strategic, planning, and operational decisions that must be
made by an apparel retailer like Giordano?   
As Giordano plans supply chain strategy it must first consider the marketing
function’s pricing plans in order to structure a supply chain consonant with these
plans. Strategic considerations such as the capacity of each supplier and assembly
operations, sourcing decisions and how logistics are to be handled are all part of
the design. The supply chain must also settle on communication channels and
frequencies.
Supply chain planning takes the strategic decisions as a given and seeks to exploit
efficiencies in the chain to maximize supply chain surplus. The entire chain
should collaborate in forecasting and planning production as to achieve a global
optimum. The forecasts should take into account planned promotions and known
seasonal fluctuations in demand.
The operational decision take the plans as a given and make day-to-day decisions
to process customer orders, allocate resources to certain customers, trigger orders
from supply chain members, and deliver product.

2. Why does ZARA source products with uncertain demand (in EU) from local
manufacturers and products with predictable demand from Asian
contractors?
Zara is a long-history brand which was opened its first store in 1975 in La Coruna,
Spain. Throughout its expansion, it remains focusing on creativity & quality design.
In the meanwhile, it also maintains a quick response rate to market demand. To
achieve this, Zara would always like to have 1) short lead time 2) tight inventory
control (limited quantities produced for each design to prevent high unsold inventory
cost) 3) high span of variety of goods to satisfy customers’ needs. In fact, sourcing
products with uncertain demand (in EU) from local manufactures enables Zara to
respond quickly to shifts in consumer demands in fashion (with short life spans). If
Zara source products with uncertain demands from Asia contractors, it may not be
able to move fast enough to deliver what customers need. Actually, Zara maintains
tight control over their production processes and signed strategic agreements with
local manufactures that ensure timely delivery and service. Only by doing so can

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Zara achieve its flexibility to design and product over 12,000 new items annually and
increase customer loyalty, which also differentiate itself from other competitors like
H&M, Gap, and Benetton. “The local strategic partnerships that Zara maintains with
manufacturers in Europe allow for a product throughput time of 3-4 weeks from
conception to distribution.” (<Zara’s Business Model>,2011) As mentioned above, the
most significant point here is to achieve the flexibility in changing orders based on
current trends. In addition, Zara also saves inventory cost under this business model,
because inventory costs is lower since it doesn’t need to place orders for a whole
season in advance and then held in distribution facilities until periodic shipment to
stores like its competitors.

On the other hand, it is still a good choice for Zara to source products with
predictable demand from Asian contractors, because it incurs a higher
manufacturing cost in Europe due to higher cost of labor and other facilities. (The cost
of production in Spain is 17-20% more expensive than Asia.) What’s more,
manufacturing products with certain demands in Asia also help to fulfill Asian market
needs sooner due to closer geographic location.

3. Offer an explain why Sasa’s inventory turns (3 times/yr) is so much slower

than Circle-K (~20/yr)?
Inventory turns computed by dividing annual sales at cost, by average aggregate
inventory value maintained during the year. Average aggregate inventory value used
to accumulate total value of all items held in inventory on the average, over some time
period.
Inventory Turns = Cost of Goods Sold/ Inventory
A product with a higher inventory turns mean the product turns money faster and
more efficient. The relationship between inventory turns and gross margin is inverse
proportional. That is the slower the inventory turns, the higher is the gross margin.
Sasa’s product is obviously having a higher gross margin (e.g. like luxury brand
perfume, makeup product, skin care product and commodity) than Circle-K’s product.
In addition, the product sold in Circle-K is generally at lower gross margin and some
maybe perishable like bread and frozen microwave cooked food, thus Circle-K’s
product turns money faster. Therefore, the inventory turns of Sasa’s are so much
slower than Circle-K’s.

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4. “Speculate” how different in their supply chains between Watsons (health
and beauty products part) and Fortress, both belonging to Hutchison
Whampoa Limited.
Watsons is a health & beauty products retailer, and it operates over 2,200 stores in
Asia and Europe (source: Wikipedia). The product coverage includes drugs,
healthcare products, foods etc. On the other hand, Fortress is a retailer mainly
focused on HK market (HK shoppers and visiting tourists) selling Digital Camera &
Camcorder, Computer & Office products, Communication Device, Electronic Game
Device, Home Appliance and other electronic products. Compared with products sold
in Watsons, electronic products in Fortress probably have shorter product lifecycles
due to high pace of technology development. It also faces problems like difficulty to
forecast products, short order delivery cycles. On the other hand, Watsons are selling
products having a relatively longer product life cycle. For example, people were using
“head & shoulders” shampoo ten years ago, and they’re stilling using it today.
However, outdated computers and other electronic devices can attract no more
customers.

As mentioned above, Watsons is selling products in 33 countries, while Fortress

mainly focuses on local market, so the transportation and distribution network could
be very different.

Inventory control: For Fortress, electronic products may need to be stored in a stricter
condition. And unit cost of goods is much higher for Fortress, while the accurate
forecast of demand is more difficult to make. For example, people could use
shampoo/soap/vitamin pills daily but when they choose to buy a new
TV/Computer/Camera is quite random due to various reasons. So Fortress is more
sensitive to customer demands.

Customer buying behavior could be quite different towards Watsons and Fortress,
which influences its individual CRM. For example, when people consume in
Watsons, they will have a shorter period of consideration time; while when customers
buy electronic products in Fortress, they may need to go to different stores to compare
the prices/models and promotions they have if any before they finally make their
decision to buy. What’s more, the electronic products have a longer warranty period
like 1-2 years, while products consumed in Watsons have probably been used up

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already. Therefore, Fortress needs to provide good after-sale services or good contact
with manufacturers if any defect problems occur.

5. Solution:
a. Inventory Turnover= Cost of Goods Sold/ Average Inventory= ($41651) /( $
3643)= 11.433
Average days to sell the inventory = 365 days/ 11.433 = 31.925≈ 32 days
Hence on average a product stay in Retailer A for about 32 days before it is sold.

b. Average Inventory (cleaner of Retailer A)= $100/11.433 = $8.74

Î Holding cost = 30% * $8.74= $ 2.622
Average Inventory (cleaner of Retailer B)= $ 100/($215493/$29447) =
$100/7.32=$ 13.66
Î Holding cost= 30% * $13.66 = $4.098
$4.098-$ 2.622 = $1.476
Therefore, on average, the inventory cost for retailer A is $1.476 lower than
retailer B holding a household cleaner valued at $100 COGS.

6. Consider two products with the same cost but different margins. Which
product should have a higher level of product availability? Why?
The product with the higher margin should be stocked at a higher level of
availability than the product with the lower margin. The product with the higher
margin will have a higher Cu, which is the cost of understocking. The cost of
understocking is the sale price less the cost and may be thought of by the supplier
as profit foregone. A higher cost of understocking results in a higher critical
fractile, so the optimal cycle service level will be higher, which will yield a higher
availability.

7. Consider two products with the same margin carried by a retail store. 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 availability? Why?
The product with the higher salvage value should be stocked at a higher level of
availability than those with the lower salvage value. The product with the higher
salvage value will have a lower Co, which is the cost of overstocking. The cost of
overstocking is the sale price less the salvage value. A lower cost of overstocking
results in a higher critical fractile, so the optimal cycle service level will be higher,
which will yield a higher availability.

8.
(a)

Cost of overstocking, CO = $ 0.50

Cost of understocking, CU = $ 1.00

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 Mean demand 50,000
Standard deviation of demand
= 15,000

Optimal CSL = = C u
=
1
= 0.67
C u
+Co 1 + 0 .5

Optimal order quantity = (NORMSINV (0.67))(15,000) + 50,000 = 56,461

(b)

Cost of overstocking, CO = $ 0.50

Cost of understocking, CU = $ 5.00

Mean demand 50,000

Standard deviation of demand
= 15,000

Optimal CSL = = C u
=
5
= 0.91
C u
+Co 5 + 0 .5

Optimal order quantity = (NORMSINV (0.91))(15,000) + 50,000 = 70,028

9.

(a)

Mean demand = 5,000

Standard deviation of demand = 2,000

Cost of overstocking, CO $ 40.00

Order size = 6,000

CSL (implied by the order size) = NORMDIST (6000-5000/2000) = 0.691

Implied cost of understocking, CU = (CO)(CSL)/(1-CSL) = (40)(0.691)/(1-0.691) =

$89.64

(b)

Mean demand = 5,000

Standard deviation of demand = 2,000

Cost of overstocking, CO

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 $ 40.00

Order size = 8,000

CSL (implied by the order size) = NORMDIST (8000-5000/2000) = 0.933

Implied cost of understocking, CU = (CO)(CSL)/(1-CSL) = (40)(0.933)/(1-0.933) = $558.74

10.

Current policy:

*
= C u
=
45
= 0.6923
CSL +Co 45 + 20
C u

Optimal lot-size = O * = NORMINV (CSL * , µ , σ ) = NORMINV(0.6923,4000,1750) =

4879
Given that p = $125, s = $60, c = $80:

Expected profits = (p – s)µ NORMDIST((O – µ)/σ, 0, 1, 1)

– (p – s)σ NORMDIST((O – µ)/σ, 0, 1, 0) – O (c – s) NORMDIST(O, µ, σ, 1)

+ O (p – c) [1 – NORMDIST(O, µ, σ, 1)] = $140,001

Expected overstock = (O – µ)NORMDIST((O – µ)/σ, 0, 1, 1) + σ NORMDIST((O – µ)/σ, 0, 1,

0) = 1,224

Southern Hemisphere option:

*
= C u
=
45
= 0.90
CSL +Co 45 + 5
C u

Optimal lot-size = O * = NORMINV (CSL * , µ , σ ) = NORMINV(0.9,4000,1750) =

6243

Given that p = $125, s = $75, c = $80:

Expected profits = (p – s)µ NORMDIST((O – µ)/σ, 0, 1, 1)

– (p – s)σ NORMDIST((O – µ)/σ, 0, 1, 0) – O (c – s) NORMDIST(O, µ, σ, 1)

+ O (p – c) [1 – NORMDIST(O, µ, σ, 1)] = $164,644

Expected overstock = (O – µ)NORMDIST((O – µ)/σ, 0, 1, 1) + σ NORMDIST((O – µ)/σ, 0, 1,

0) = 2,326

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