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Prepared by Dr. A. K. Dey Based on Third Chapter of Simchi-Levi, Kaminsky & Simchi-Levi
Dr. A. K. Dey
Supply Contracts
Fixed Production Cost =$100,000 Variable Production Cost=$35
Manufacturer DC
Retail DC
Stores
Dr. A. K. Dey 2
Demand Scenarios
Demand Scenarios
30% 25% 20% 15% 10% 5% 0%
Probability
80 00
10 00 0
12 00 0
14 00 0
16 00 0
Sales
Dr. A. K. Dey 3
18 00 0
8000
10000
12000
14000
16000
18000
20000
Order Quantity
Dr. A. K. Dey
8000
10000
12000
14000
16000
18000
20000
Order Quantity
Dr. A. K. Dey
Demand
Prob
80000 40000 0 0
16000
18000
0.185
0.095
1500000
1500000
960000
960000
100000
100000
0
0
540000
540000
99900
51300 470700
440000
440000
81400
41800 440000 910700
Dr. A. K. Dey
Supply Contracts
Fixed Production Cost =$100,000 Variable Production Cost=$35
Manufacturer DC
Retail DC
Stores
Dr. A. K. Dey 8
Dr. A. K. Dey
Retailer orders for 12000 swimsuits with buy back arrangement Sales Price 125 8000 10000 12000 14000 16000 18000 0.11 0.11 0.275 0.225 0.185 0.095 1000000 1250000 1500000 1500000 1500000 1500000 Buy Back 55 220000 110000 0 0 0 0 Wholes le Price 80 960000 960000 960000 960000 960000 960000 Variale cost 35 420000 420000 420000 420000 420000 420000 Fixed cost 100000 100000 100000 100000 100000 100000 100000
Demand
Prob
Profit
Average Profit
493800
403700 897500
Dr. A. K. Dey
10
Retailer orders for 14000 swimsuits with buy back arrangement Demand Prob Sales Price
125
Buy Back
55
Variable cost
35
Fixed cost
100000 Retailer
Profit
Average Profit
Manuf
Retailer
Manuf
8000 10000
0.11 0.11
1000000 1250000
330000 220000
1120000 1120000
490000 490000
100000 100000
210000 350000
200000 310000
23100 38500
22000 34100
12000
14000 16000 18000
0.275
0.225 0.185 0.095
1500000
1750000 1750000 1750000
110000
0 0 0
1120000
1120000 1120000 1120000
490000
490000 490000 490000
100000
100000 100000 100000
490000
630000 630000 630000
420000
530000 530000 530000
134750
141750 116550 59850 514500
115500
119250 98050 50350 439250 953750
Dr. A. K. Dey
11
Demand
Prob
Sales Price
Buy Back
Variable cost
Fixed cost
Profit
Average Profit
125 8000 10000 12000 14000 16000 18000 0.11 0.11 0.275 0.225 0.185 0.095 1000000 1250000 1500000 1750000 2000000 2000000
Best case Profits for both increase. With buy back arrangement manufacturer should push for 16000 units order.
Dr. A. K. Dey
12
Supply Contracts
Fixed Production Cost =$100,000 Variable Production Cost=$35
Manufacturer DC
Retail DC
Stores
Dr. A. K. Dey 13
Dr. A. K. Dey
14
Demand
Prob
Profit
Average Profit
125
15%
60
35
100000
Retailer
ManuF
Retailer
Manuf
Total SC Profit
Dr. A. K. Dey
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Demand
Prob
Sales Price
Rev Share
Profit
Average Profit
125 8000 10000 12000 14000 16000 0.11 0.11 0.275 0.225 0.185 1000000 1250000 1500000 1750000 1750000
18000
0.095
1750000
262500
840000
490000
100000
647500
512500
SUM
61513
472188
48688
481563 953750
Best case. Profits for both increase. Retailer should negotiate for reduction in the wholesale price to $60 by committing to lift 14000 units.
Dr. A. K. Dey
Total SC Profit
16
Demand
Prob
Sales Price
Rev Share
Profit
Average Profit
125
15%
60
35
100000
Retailer
Manuf
Retailer
Manuf
8000
0.11
1000000
150000
960000
560000
100000
-110000
450000
-12100
49500
10000
0.11
1250000
187500
960000
560000
100000
102500
487500
11275
53625
12000
0.275
1500000
225000
960000
560000
100000
315000
525000
86625
144375
14000
0.225
1750000
262500
960000
560000
100000
527500
562500
118688
126563
16000
0.185
2000000
300000
960000
560000
100000
740000
600000
136900
111000
18000
0.095
2000000
300000
960000
560000
100000
740000
600000 SUM
70300 411688
Total SC Profit
Dr. A. K. Dey
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Supply Contracts
Strategy Sequential Optimization Buyback Revenue Sharing Retailer Manufacturer 470,700 440,000 503,700 450,050 472,188 481,573 Quantity Sequential Optimization 12000 Buyback 16000 Revenue Sharing 14000 Total 910,700 953,750 953,761
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Supply Contracts
Fixed Production Cost =$100,000 Variable Production Cost=$35
Manufacturer DC
Retail DC
Stores
Dr. A. K. Dey 19
60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0
Production Quantity
Dr. A. K. Dey 20
35 560000 560000
12000
14000 16000 18000
0.275
0.225 0.185 0.095
1500000
1750000 2000000 2000000
560000
560000 560000 560000
100000
100000 100000 100000
80000
40000 0 0
920000
1130000 1340000 1340000
253000
254250 247900 127300 1015550
Dr. A. K. Dey
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Supply Contracts
Strategy Sequential Optimization Buyback Revenue Sharing Global Optimization Retailer Manufacturer 470,700 440,000 503,700 450,050 472,188 481,573 Total 910,700 953,750 953,761 1,015,550
Quantity Sequential Optimization 12000 Buyback 16000 Revenue Sharing 14000 Global Optimization 16000
Dr. A. K. Dey
22
Buy Back and Revenue Sharing contracts achieve this objective through
risk sharing
Dr. A. K. Dey
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Blockbuster purchases a copy from a studio for $65 and rent for $3
Hence, retailer must rent the tape at least 22 times before earning profit
Even if Blockbuster keeps only half of the rental income, the breakeven point is 6 rental per copy The impact of revenue sharing on Blockbuster was dramatic
Rentals increased by 75% in test markets Market share increased from 25% to 31% (The 2nd largest retailer, Hollywood Entertainment Corp has 5% market share)
Dr. A. K. Dey 25
Other Contracts
Quantity Flexibility Contracts
Supplier provides full refund for returned items as long as the number of returns is no larger than a certain quantity
(s, S) Policies
For some starting inventory levels, it is better to not start production If we start, we always produce to the same level Thus, we use an (s,S) policy. If the inventory level is below s, we produce up to S. s is the reorder point, and S is the order-up-to level The difference between the two levels is driven by the fixed costs associated with ordering, transportation, or manufacturing
Dr. A. K. Dey 27
Reminder:
Standard Deviation = 10
Average = 30
0 10 20 30
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50
60
29
Satisfy demand during lead time Protect against demand uncertainty Balance fixed costs and holding costs
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Inventory Level
Lead Time
s 0 Time
Dr. A. K. Dey 32
Notation
AVG = average daily demand STD = standard deviation of daily demand LT = replenishment lead time in days h = holding cost of one unit for one day K = fixed cost SL = service level (for example, 95%). This implies that the probability of stocking out is (100%-SL) (for example, 5%) Also, the Inventory Position at any time is the actual inventory plus items already ordered, but not yet delivered.
Dr. A. K. Dey 34
Analysis
The reorder point (s) has two components:
To account for average demand during lead time: LTAVG To account for deviations from average (we call this safety stock) z STD LT where z is chosen from statistical tables to ensure that the probability of stockouts during leadtime is 100%-SL.
Since there is a fixed cost, we order more than up to the reorder point: Q=(2 K AVG)/h The total order-up-to level is: S=Q+s
Dr. A. K. Dey 35
TV Distributor
Trying to set inventory policies Fixed ordering cost of $4500 Cost of TV set $250 and annual inventory holding cost 18% of product cost Replenishment lead time is 2 weeks Average weekly demand is 44.58 and the standard deviation of monthly demand is 32.08 Desired CSL 97%
Dr. A. K. Dey 36
Example
The distributor has historically observed weekly demand of: AVG = 44.58 STD = 32.08 Replenishment lead time is 2 weeks, and desired service level SL = 97% Average demand during lead time is: 44.6 2 = 89.2 (or 90) Safety Stock is: 1.88 32.1 2 = 85.3 (or 86) Reorder point is thus 176, or about 3.9 weeks of supply at warehouse and in the pipeline
Dr. A. K. Dey 37
Example, Cont.
Weekly inventory holding cost: 0.87
Therefore, Q=679
Distributor should place order to raise the inventory position to 855 TV sets whenever the inventory level is below or at 176 Average inventory level is (679/2)+86= 426
Dr. A. K. Dey 38
Periodic Review
Suppose the distributor places orders every month What policy should the distributor use? What about the fixed cost?
Dr. A. K. Dey 39
Base-Stock Policy
r r L
L
Inventory Position
Inventory Level
Base-stock Level
0 Time
Dr. A. K. Dey 40
TV Distributor .
Suppose the distributor places order every three weeks Average demand during five weeks is 223 Standard deviation is (1.88x32.1xSqRt 5) = 134.94 (or 135) Base stock level is (223+135) = 359 TVs Average inventory level 202
Dr. A. K. Dey 42
Risk Pooling
Consider these two systems:
Warehouse One
Supplier Warehouse Two Market Two Market One
Risk Pooling
For the same service level, which system will require more inventory? Why? For the same total inventory level, which system will have better service? Why? What are the factors that affect these answers?
Dr. A. K. Dey
44
4 38 40 78 0 0 0
5 55 26 81 0 3 3
6 30 48 78 1 1 2
7 18 18
8 58 55
36 113 3 0 3 0 0 0
46
Market 1
1.125
1.36
1.21
Market 2
1.25
1.58
1.26
Dr. A. K. Dey
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Mkt 1 Mkt 1
A B A B A B
39.3 1.1
13.2 1.4
0.34 1.21
25.08 2.58
64.4 3.7
132.2 22.4
196.5 26.1
91.16 13.76
92 14
Mkt 2
38.6
12.0
0.31
22.80
61.4
131.0
192.4
88.29
89
Mkt 2
1.3
1.6
1.26
3.00
4.3
23.6
27.8
14.79
15
Total
77.9
20.7
0.27
39.35
117.2
186.1
303.3
132.38
133
36
Total
2.4
1.9
0.80
3.61
6.0
32.5
38.5
19.85
20
45
Dr. A. K. Dey
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49
Orders
10
11
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13
14
15
50
Demands
Dr. A. K. Dey
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Centralized Systems*
Supplier
Warehouse
Retailers
Centralized Decision
Dr. A. K. Dey 52
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Dr. A. K. Dey
Dr. A. K. Dey
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Forecasting
Recall the three rules Nevertheless, forecast is critical General Overview:
Judgment methods Market research methods Time Series methods Causal methods
Dr. A. K. Dey 59
Judgment Methods
Assemble the opinion of experts Sales-force composite combines salespeoples estimates Panels of experts internal, external, both Delphi method
Each member surveyed Opinions are compiled Each member is given the opportunity to change his opinion
Dr. A. K. Dey 60
Market surveys
Data gathered from potential customers Interviews, phone-surveys, written surveys, etc.
Dr. A. K. Dey 61
Causal Methods
Forecasts are generated based on data other than the data being predicted Examples include:
Inflation rates GNP Unemployment rates Weather Sales of other products
Dr. A. K. Dey 63
How important is the past in estimating the future? Different approaches may be appropriate for different stages of the product lifecycle:
Testing and intro: market research methods, judgment methods Rapid growth: time series methods Mature: time series, causal methods (particularly for long-range planning)