Uncoordinated Supply Chain

By
Prof. M. K. Tiwari
Dept of IE&M
IIT Kharagpur
 Co-ordination In Supply
Chain
Coordination in Supply Chain Refer as the coordination
of information, materials and financial flow between
organizations in supply chain.

Brings many organizations as an united team with well

established communication channels and optimized
resource allocation.
Why Supply Chain Suffers?

When each member of supply chain tries to maximize

their own profit.

When each member or group of supply chain tries to

optimize individually instead of coordinating their
efforts.
Why Coordination is Important
in SCM?
Communication and Coordination among members of
a supply chain enhances its effectiveness which lead
to the benefit of whole supply chain.

For success in the global marketplace requires whole

supply chains to compete against other supply chains.
Kind of coordination involve
in SC
Horizontal Coordination
Coordination among entities involve at same level
of Supply Chain.
Example: Coordination between supplier to supplier or within the firm.

Vertical Coordination
Coordination among entities involve at different
levels of Supply Chain.
Example: Coordination between supplier to retailer or distributor to retailer
 Problems in SCM due to Low
Involvement of coordination
1. Location Decision of Franchisees of One
Organization
2. Warehouse Decision for Organization
3. Lot sizing problem with deterministic demand
4. Demand Forecasting in Supply Chain
5. Product Pricing and Marginal cost Problem between
Suppliers and Retailers
6. Lot sizing problem with stochastic demand in a
News-vendor environment
Location Decision of Franchisees
of One Organization
Location Decision of Franchisees of One
Organization
A franchise has multiple outlet to serve customers,
spread out over a town, a city or country.
Problem for franchise is, where they have to locate
their franchisees to get maximum profit in Supply
Chain.
In two ways they can select location
Two or more Franchisees whose location are coordinated by
Franchisor.
Two or more Franchisees that control their own location.
 Example: Location Decision of
Franchisees
Isaacs Ice Cream had been selling ice-creams in the
city, now Isaac wanted to expand his market to reach
summertime tourist by selling his ice-creams through
small-carts along the boardwalk on 4 mile beach.

Isaac company decided to open two franchisees on

the beach in 4 mile boardwalk.
 Example: Location Decision of
Franchisees
Now Isaac company has two option to establish these
franchisees;

Two Franchisees whose locations are coordinated

by Isaac company (Franchisor).

Two Franchisees that control their own locations.

 Example: Location Decision of
Franchisees
Suppose that a franchisor wishes to open two ice
cream parlor along a stretch of road 4-mile long.

Potential customers cluster with mile marker [MM]

0,1,2,3 & 4 and each cluster has n number of
customer.

Customer demand is sensitive primarily to distance

traveled by customer.
 Example: Location Decision of
Franchisee 1 Franchisees
Franchisee 1 Franchisee 1

MM 00 MM 01 MM 02 MM 03 MM 04
n n n n n
customer customer customer customer customer

1 Mile 2 Mile 3 Mile 4 Mile

Franchisee 2

4 Mile Beach with n customers on each clusters

Case 1: Franchisor choosing location for both Franchisees

Case 2: Two Franchisees that control their own locations
 Two Franchisees whose locations are
coordinated by Franchisor
If the franchisor can locate these franchisees anywhere
on the 4-mile of the road, the franchisor will try to
maximize total demand of supply chain.

Demand for franchise will be maximized when the

franchise 1(F1) is located at MM1 and franchise 2(F2)
is located at MM3.
 Two Franchisees whose
locations are coordinated by
Franchisor
Total demand depends on distance traveled by customer,
hence, Demand D given as;
4
D na (b d i ) where d=distance traveled by customer
i 0
For Franchise 1 demand D1
na
D1 na (b 1) na (b 0) (b 1)
2
n Number of customer on each mile
a Constant, a 0
b Constant, b 4
 Two Franchisees whose
locations are coordinated by
Franchisor
For Franchise 2 demand D 2

na
D2 na (b 1) na (b 0) (b 1)
2
n Number of customer on each mile
a Constant, a 0
b Constant, b 4
Total demand for Supply Chain;

D na(b 1) na (b 0) na (b 1) na (b 0) na (b 1)
D na(5b 3)
 Two Franchisees that control their own
locations
In this case, both franchisee try to maximize their own
profit and demand, knowing that the other franchisee
exists and reacting accordingly.
In this case best location for each one is MM2 and if
both franchisees chooses MM2 then;
Total demand D;
D na (b 2) na (b 1) na (b 0) na (b 1) na (b 2)
D na (5b 6)
Warehouse Decision for
Organization
Warehouse Decision for Organization

The warehouse is a point in the logistics system where

a firm stores or hold raw materials, semi finished
goods or finished goods.

The firms can use distributed warehousing or

centralized warehousing for storage system.
 Example: Warehouse Decision for
Organization
Isaacs Ice Cream has grown and now selling their
products over the other state through 200 retail-
outlets, which are equally distributed between these
two states.
In first state, Isaac company leased warehouse space
near each shop.
In second state, Isaac company tried storing goods for
all 100 shops in that state at a central location.
 Example: Warehouse Decision for
Organization
In second state, company pays only for storage space
and ordering and receiving costs.
Firm has always carried safety stock to protect
against unusual high demand.
In centralized warehousing, two benefits are
involved;
Economies of scale in setup costs and holding costs
Risk pooling in stochastic demand environment
 Economic Order Quantity
Costs
Benefits of centralized warehousing in terms of
economies-of-scale given by EOQ,

For distributed warehousing;

EOQR1 2 DS / H , EOQR2 2 DS / H ................., EOQRN 2 DS / H

For N Clients;
D Annual Demand
EOQD N 2 DS / H H hoslding Costs
S Setup Costs
N Number of Clients
 Economic Order Quantity
Costs
Benefits of centralized warehousing in terms of economies-
of-scale given by EOQ,
For Centralized Warehousing

D Annual Demand
For N Clients; H hoslding Costs
EOQC 2( ND) S / H S Stup Costs
N Number of Clients
In this condition supplier combine the whole demand
instead of single client demand.
 Economic Order Quantity
Costs
The saving percent for centralized warehousing with
EOQEOQof of
respect to distributed warehousing; Coordinated
Distributed SCSC

N 2 DS / H 2 NDS / H
Saving % 100
N 2 DS / H
( N N ) 2 DS / H
Saving % 100
N 2 DS / H
N N
Saving % 100
N
N
Saving % 1
100
N
 Numerical Example:SolvingEconomic
as
Order Quantity Costs
Saving %=(1-N/N)*100
=(1- 7/7)*100
=(1-0.3779)*100
With regard to EOQ costs, Saving %= [1-(N)/N]x100
=62.20%
Number of Clients Cost Saving % Number of Clients Cost Saving %
2 29.29 11 69.85
3 42.26 12 71.13
4 50.00 20 77.64
5 55.28 25 80.00
6 59.18 40 84.42
7 62.20 50 85.86
8 64.64 100 90.00
9 66.67 1000 96.84
10 68.38 2500 98.00
 Risk pooling benefits in
Centralized Warehousing:
Newsvendor Environment
Suppose that ith firm choosing its optimal order
quantity has expected overage and underage costs
equal to Ki.
Where i is firms is standard deviation of demand
And K is constant.
For distributed SC
Each client has same overage and underage cost per
unit, but with normal probability demand distribution
with mean and variance 2;
For N client overage and underage cost = NK
 Risk pooling benefits in
Centralized Warehousing:
Newsvendor Environment
For Centralized SC
If supplier combines the demands of its all clients N,
Normal probability demand distribution with mean N and
variance N2,

For N client overage and underage cost ,

Overage & Underage Costs K N 2

Overage & Underage Costs N K
N
Saving % 1
100
N
 Risk pooling benefits in
Centralized Warehousing: Safety
Stock & Service Level
The safety stock equals to z, where z represents the
number of standard deviation over the mean to
achieve a desired cycle service level,
In distributed warehousing system,
Safety Stock Level for Supply Chain = zN
In centralized warehousing system,
Supplier combines the demand for all clients

Safety Stock Level for Supply Chain = zN

 Risk pooling benefits in Centralized
Warehousing: Safety Stock & Service
Level
Saving Cost % for it coordinated SC,
N
Saving % 1
100
N

Service Levels can improve in centralized warehousing system

by improving z value in centralized warehousing;
Standard
deviation in
zold N znew N Standard
deviation in
coordinated SC distributed SC
znew N zold
 Numerical Example: Cycle Service
Level Znew
Number of 70.00% 80.00% 90.00%
Clients Zold = 0.5244 Zold =0.8416 Zold =1.2816levels from Z
Service
2 77.08% 88.30% 96.50% table
For 2 clients, at z old =0.5244 ;
3 81.81% 92.75% 98.68%
znew 2 * zold
4 85.29% 95.38% 99.48%
znew 0.7416
5 87.95% 97.01% 99.79%
At 0.7416 Service level=77.08%
6 90.05% 98.04% 99.92%
7 91.73% 98.70% 99.97%
8 93.10% 99.14% 99.99%
9 94.22% 99.42% 99.99%
10 95.14% 99.61% 100.00%
15 97.51% 99.94% 100.00%
25 99.56% 100.00% 100.00%
50 99.99% 100.00% 100.00%
100 100.00% 100.00% 100.00%
Lot sizing problem with
deterministic demand
 Coordinated Lot Sizes with
Deterministic Demand
Some product has an expensive setup cost and a very
fast production rate.

And it is cheapest to produce it in lot size instead of

producing small number size.

It is optimal for the suppliers lot size of production

(lot size for supplier) to be an integer multiple of the
retailers lot size.
 Coordinated Lot Sizes with
Deterministic Demand
Total annual supply chain setup cost and holding cost
are given as;
D n 1 Q D Q
TC S
s H s
r H r ..........(1)
S
nQ 2 Q 2
D Annual demand D
S s Supplier's setup cost S s Supplier's annual setup costs
nQ
S r Retailer's setup cost
n 1 Q
H s Supplier's holding cost H s Supplier's annual average holding
2
H r Retailer's holding cost
Q Retailer's order size D
S r Retailer's annual setup costs
n Supplier's integer lot-size multiplier Q
nQ Supplier's lot-size Q
H r Retailer's annual average holding costs
x the greatest integer x 2
 Coordinated Lot Sizes with
Deterministic Demand
Differentiate equation (1) of total supply chain annual
setup and holding cost TC with respect to Q;
D n 1 Q D Q
TC S
s H S
s r rH ..........(1)
nQ 2 Q 2
TC DS s (n 1) H s DSr H r
2 2 ............................(2)
Q Qn 2 Q 2
Putting equation(2) equal to 0;
TC DS s DS r (n 1) H s H r
0; 2 2 0
Q Q n Q 2 2
H DS DS H
(n 1) s 2 s 2r r
2 Qn Q 2
Coordinated Lot Sizes with
Deterministic Demand

2 DS DS r H r 2 DSr
n(n 1) s
n n ; Q=
Hs Q
2
2 DS r 2 Hr
Hr

2 DS s nH r H r
n(n 1) 2
n ;
Hs Q 2 2

2 DS s
n2 n
H sQ 2
2 DS s
n n
2
2
0...................(3)
H sQ
Coordinated Lot Sizes with
Deterministic Demand
From equation (3);
2 DS s
n2 n 2
0.......................(3)
H sQ
By Formula;
b b 2 4ac
x ;
2a
1 2 DS s
n 1 1 4 1
2 H s Q 2
Suppliers
We have to maximize the lot-size; multiple
Integer for

1 8 DS s Quantity
n 1 1 2
2 H sQ
 Coordinated Lot Sizes with
Deterministic Demand
When the parties optimize independently, the retailer
orders Q* and the supplier orders (n*Q* ),
where,
* 2 DS r
Q =
Hr

and

1 8 DS s
n 1 1 2
2 H s Q
 Coordinated Lot Sizes with
Deterministic Demand
When they optimize jointly, they go through these steps;
Step1:
1 4Ss ( H r H s )
n 1 1 Max 0,
2 Sr H s

Step 2 :
Ss
S * S r and H ( n* 1) H s H r
n
S
Therefore; Q *
2D
H
 Numerical Example: Coordinated
Lot Sizes with Deterministic
For example, considerDemand
a product with annual demand
D=25,000 unit, Ss=$200, Sr=$40.50, Hs=$2.00, and
Hr=$2.50;
2 2500 40.5
Q* 900 Unit
2.5
Therefore;
1 8 25000 200
n*
2
1 1
2 900 2
Hence;

1 Qs n* Q* 3 900
n* 1 5.07
2 Qs 2700 Unit
n 3
*
Numerical Example: Coordinated
Lot Sizes with Deterministic
25000
Demand
3 1 900 25000
900
TC * 200 2 40.50 2.5
3 900 2 900 2
TC * $5902

If they Jointly optimize their lot-size;

1 4 200(2.5 2)
n 1 1 Max 0,
2 40.50 2
1
n 1 2.42 1
*

2
 Numerical Example:
Coordinated Lot Sizes with
Deterministic
S Demand
S S and H (n 1) H H
s *
* r s r
n
200
S 40.50 and H (1 1)2.0 2.5
1
S $240.5 and H $2.50
S
Q* 2 D
H

2 25000 240.5
Q* 2193 Unit
2.5
 Numerical Example:
Coordinated Lot Sizes with
Deterministic
Retailer orders 2193 unit and soDemand
does the supplier
orders 1x2193=2193 unit and total setup and holding
cost = $5483, and its 7.1 % lower than individual
optimized order quantity holding and setup cost.

In jointly optimization retailers holding and setup

cost is increase and so it should be compensate by
supplier by giving some quantity discount to retailer.
 Numerical Example:
Coordinated Lot Sizes with
Deterministic Demand
Benefits of lot-sizing;
Ss/Sr Qnew/Qold Cost Saving
%
1 1.41 5.72 S s S r
2 1.73 13.40
Cost Saving 1 2 1 ( S s S r ) S r
Sr
3 2.00 20.00
Ss
4 2.24 25.46
Cost Saving 1 2 1 2S s
S r
5 2.45 30.01
Sr
10 3.32 44.72
15 4.00 52.94
20 4.58 58.34
50 7.14 72.53
100 10.5 80.29
Demand Forecasting in Supply
Chain
 Coordinated Demand
Forecasting
Demand of products varies from downstream to
upstream in supply chain due to bullwhip effect in
supply chain.

As demand of products varies in supply chain, So

forecasting of demand of product also varies from
downstream to upstream.

Due to lack of communication between retailers,

distributor, wholesaler and supplier demand
forecasting may suffer in supply chain.
 Example: Coordinated Demand
Forecasting Next period
Wholesaler and Retailer work individually without sharing any information
Forecast=Current
consumers Demand

Table 1
Example: Coordinated Demand
Forecasting
Wholesaler and Retailer sharing consumers demand information

Table 2
Example: Coordinated Demand
Forecasting
Equations for Table 1;
For Retailer,
Next period forecast= Consumer current demand
C5 = B5
*On-hand Inventory =

Max[( Previous On-hand Inventory + Previous In Transit

Inventory Previous Back order Current Consumer
demand),0]
D5= MAX(D4 + G4 E4 B5, 0)
= Max(0+5-0-5,0) = 0
 Example: Coordinated Demand
*
Forecasting
Back Order =
Max[( Previous Backorder + Current Consumer demand
Previous On-hand Inventory Previous In Transit Inventory),
0]
E5 = MAX( E4 + B5 D4 G4, 0) = Max(0+5-0-5, 0) = 0
*Order Placed by Retailer =

Max[( Next Period forecast (On-hand Inventory +

wholesalers Previous Backorder Retailers Previous
Backorder)), 0]
F5 = MAX ( C5 (D5 + J4 E5), 0) = Max[5-(0+0-0), 0] = 5
 Example: Coordinated Demand
Forecasting
*InTransit Inventory for Retailer =
Min[( Order Placed by Retailer + Wholesalers Previous
Backorder), (Wholesalers On-hand Inventory + wholesalers
In Transit Inventory)]
G5 = MIN (F5 + J4 , I4 + L4)= Min(5+0, 0+5)= 5
Equations for Table 1;
For Wholesaler;
*Next Forecast = Order Placed by Retailer

H5 = B5
 Example: Coordinated Demand
*
Forecasting
Wholesalers On-hand Inventory =
Max[( Previous On-hand Inventory + Previous In Transit
Inventory Previous Backorder Order Placed by Retailer ) ,
0]
I5 = MAX ( I4 + L4 J4 F5 , 0 ) = Max(0+5-0-5, 0)=0
*Wholesalers Backorder =

Max[( Wholesalers Previous Backorder + Order Placed by

Retailer - Previous Wholesalers On-hand Inventory
Previous Wholesalers In Transit Inventory) , 0]
J5 = MAX ( J4 + F5 I4 L4 , 0 ) = Max(0+5-0-5, 0)= 0
 Example: Coordinated Demand
Forecasting
*Order Placed by Wholesaler =
Max[( Next Period forecast (Wholesalers Current On-hand
Inventory Current Backorder for Wholesaler) , 0]
K5 = MAX ( H5 (I5 J5) , 0 )=Max[5-(0-0), 0]= 5
For Table 2,
Everything will remain same except Next period forecast of
wholesaler.
Next Period forecast for wholesaler = Current Consumer
demand
H5 = B5
Example: Coordinated Demand
Forecasting
From table 1, wholesalers forecast equal to the order
received from retailer in current period.

And therefore wholesalers on-hand inventory is very

high due to low information sharing between them.

From table 2, retailer and wholesaler are sharing the

information of customer demand.
Example: Coordinated Demand
Forecasting
Therefore wholesalers forecasting is equal to
retailers forecasting.

When demand information is shared, the wholesalers

total on-hand inventory held over 20 periods is 42%
smaller.
= (395-230)/395 = 42%

In the uncoordinated case wholesaler overreacting to

the retailers catch-up order and assuming that
consumer demand will be larger in future.
Product Pricing and Marginal cost
Problem between Suppliers
and Retailers
 Coordinated Pricing
Pricing of products is important factor for demand
and demand vary according to pricing.

The Supply Chain loses money when the firms do not

coordinate their pricing.

In traditional way, supplier first set the wholesale

price and the retailer react accordingly and set his
own price according to his marginal cost.
 Coordinated Pricing

In pricing, can explain by taking two cases;

Case 1: A System with One Retailer and One Supplier
Case 2; A System with One Retailer and N-1 Supplier

Suppose
P = Retail Price of Product
Q = Quantity Sold
Retailer's Demand Curve;
P 900 2Q.......(4)
Case 1: A System with One Retailer and One
Supplier
Let Marginal cost for supplier and retailer equal to
$90 and $10 respectively.
Total Revenue for Retailer = PxQ
P Q 900Q 2Q 2 ................(5)

Marginal Revenue for Retailer is the derivative of

total revenue (eq.1) with respect to Q;
Retailer's Marginal Revenue 900 4Q.......(6)
Case 1: A System with One Retailer and One
Supplier
Taking Retailer and supplier as a one firm.
Total Marginal Cost for Supply Chain=$90+$10
=$100
Optimal quantity Q* given as;
900 4Q 100
Q* 200 Unit
P 900 2 200 $500
Total Channel profits = Q(P-C) ..(7)
= 200[500-($90+$10)]=$80,000
Where C = Supply Chain Marginal Costs
Case 1: A System with One Retailer and One
Supplier
Taking Retailer and supplier as two individual part of
Supply chain.
From eq.6, wholesaler know that Retailer will set
marginal cost according to wholesalers price charged.
So, 900-4Q=10 + W
Where W = Wholesale price charged
Therefore demand curve for Supplier;
W = 890 4Q (8)
Therefore suppliers total revenue W x Q = 890Q-4Q2
 Case 1: A System with One
Retailer and One Supplier
Marginal Costs = 890 8Q (9)
From this equation;
90 = 890 8Q
(As marginal cost for supplier is $90)
Q* = 100 Unit
W* = 890 4 x 100 (From Equation 8)
W* = $490
Total revenue of Supplier = 100[$490 - $90] = $40,000
(From eq. 7)
 Case 1: A System with One
Retailer and One Supplier
Retailer also will sell same quantity as suppliers.
Retail Price P = 900 2 x 100
Retail Price P* = $700
(From equation (4))
Total revenue for Retailer = 100[$700-($10+$490)]
= $20,000
Total Channel Profit = $40,000 + $ 20,000
= $ 60,000
Which is 33% lesser than coordinated pricing, Cooperative
optimization produces more than independent optimization
would produce.
Case 2: A System with One Retailer and N-1
Supplier
Now in this case, One Retailer and N-1 Suppliers are
involve.
In this, supply chain consisting of one retailer, and
retailers supplier and retailers suppliers supplier and so
on.
In this case Retailers linear demand curve given as;
P a bQ ..........(10)
Where (a, b>0 )
(Retailer faces a deterministic linear demand curve of the form of P 1)
Case 2: A System with One Retailer and N-1
Supplier
Now let C represent the system profit under
coordination pricing and U represent the system profit
under uncoordinated pricing.

Let Ci be the marginal cost of firm i (i=1,2,3N)

and where i = 1 denotes the retailer, i = 2 denotes
the retailers supplier and i = 3 denotes the retailer's
suppliers supplier.
Case 2: A System with One Retailer and N-1
Supplier
Pi denote the price charged by firm i.

Q is a decision variable and represent the quantity

sold to the final customer.

Q* represent the optimal quantity for profit

maximization.
Case 2: A System with One Retailer and N-1
Supplier
For Coordinated Supply Chain
If there is coordination among the N firms, all the N
firms are considered as one organization,

Thus Marginal revenue; Q P Q
Q
aQ bQ a 2bQ2

..............(11)
and Marginal Cost given as;
Marginal cost= i Ci

Retail Price P1 given as;

P1 (a i Ci ) / 2 .......(12)
With the exception of firm N(the most upstream member of
supply chain), Ci doest not include the purchase price.
Let Pi denote the pricing charge by firm i.
The decision variable Q represents the quantity sold to the final
customer and Q* represents the optimal(profit-maximizing)
quantity.
The retailer faces a deterministic linear demand curve of the form
of
P1=a bQ
equating Marginal revenue a 2bQ with marginal cost ( Ci ), we get
a Ci
Q
2b
TheValue of Q putting in equation(10)
a Ci a Ci
P1 a bQ a b
2b 2
Case 2: A System with One Retailer and N-1
Supplier
For Coordinated System, Value of eq. (12) putting in eq.
(10);
a C i i
a bQ
Ci Marginal Cost For i Firm
th

2 Pi Price Charged by i Firm

th

bQ *
a
a C i i Q Quantity Sold
2 Q Optimal Quantity For Profit Maximization
*

1 N

Q a Ci
*
............(13)
2b i
So, total Profit C given as;
c Q* ( P1 i Ci ) .........(14)
Case 2: A System with One Retailer and N-1
Supplier
From equation 13 and 14;
1 N

c a Ci ( P1 i Ci )
2b i
1 N
a Ci
a Ci i Ci
2b i 2
1 N
a i Ci
a Ci
2b 2
i
2
1 N

a Ci
4b i
Total profit in coordinated Supply Chain;
2
1 N

c a Ci ..............(15)
4b i 1
Case 2: A System with One Retailer and N-1
Supplier (For Uncoordinated Supply Chain)
The tier 1 supplier(i=2) knows that the retailer will chose the
quantity by equating its marginal revenue with its marginal cost.
Marginal revenue= P1 = a-2bQ
Marginal cost =C1 +P2 where C1= marginal cost of retailer

a-2bQ = C1+P2 Marginal revenue of P2 P2Q a C1 Q 2bQ 2
Q Q
(a C1 ) 4bQ
P2=( a-C1)-2bQ Marginal cost P2 P3 C2
( a C1 ) 4bQ P3 C2
P3 [a (C1 C2 )] 4bQ
P3 [a (C1 C2 )] 231 bQ
C2= marginal cost of retailers supplier
C3= marginal cost of retailers suppliers supplier
Continuing in
this
m 1
fashion
up the supply chain, we get
m


P a C 2m 1 bQ
i 1

i

...............(16)

where m=1,2,3......N and where m is mth firm

Case 2: A System with One Retailer and N-1
Supplier
Putting m=N+1; System contain One
Retailer and N-1
Suppliers therefore
N

PN 1 a Ci 2 N bQ PN+1=0
i 1
but PN 1 0
N



a
i 1
Ci

2 N
bQ 0

1 N

Q N a Ci .................(17)
*

2 b i 1
 Case 2: A System with One
Retailer and N-1 Supplier m

Pm+1= a Ci 2 bQ
m

i 1

The Profit of Firm m equals;

U m Q* ( Pm Pm 1 Cm )
PPm+1
m

Putting all values;

* m 1
m
*

U m Q a Ci 2 bQ a Ci 2 bQ Cm
m 1 * m

i 1 i 1

*
m 1
*
m
*

U m Q a Ci Cm 2 bQ a Ci 2 bQ
m 1 m

i 1 i 1
 Case 2: A System with One
Retailer and N-1 Supplier
m 1
m

a Ci Cm a Ci
i 1 i 1

From above equations;

*
m
*
m
*

U m Q a Ci 2 bQ a Ci 2 bQ
m 1 m

i 1 i 1

U m Q 2 bQ 2
* m * m 1
bQ *

m 1
U m Q 2 *
bQ (2 1)
*

U m 2 b Q m 1

* 2
 Case 2: A System with One
Retailer and N-1 Supplier
*
Putting Value of Q from equation (17);
2
1
N
U m 2 m 1
b N a Ci
2 b i 1
m 1 2
2 N
U m 2 N a Ci Multiplying
2 b i 1 by 4 in
numerator &
Profit For firm m; denominator

m 2 N 1 2
2 N

U m
4b

a
i 1
Ci ...........(18)

 Case 2: A System with One
Retailer and N-1 Supplier
Similarly total profit for Supply Chain;
U 1 2 .......... U m
Putting values of these profits;
2 2 N 2 3 2 N 2
2 2 N
N
U a Ci a Ci
4b i 1 4b i 1

42 N 2 m 2 N 1 2
2
N
2 N
a Ci ........ a Ci
4b i 1 4b i 1

.............(19)
 2
1 N

U
4b
a
i 1
Ci

2 2 2 N 23 2 N ... 21 N

2
1 N


4b
a Ci
22 2 N
2 0
21 22 ... 2 N 1
i 1
2
1 N
2 N 11 1

4b
a Ci

2
22 N

2 1

i 1
2
1 N


4b
a Ci
22 2 N
2 N
1
i 1
2
1 N


4b
a
i 1
Ci

2 2 2 N N 2 2 2 N

2
1 N

4b
a
i 1
Ci

2 2 N 2 2 2 N
 C U
System Profit Ratio
U
2 2
1
N
1 N

4b
a
i 1
Ci


4 b a
i 1
Ci 2 2 N 2 2 2 N
2
1 N

4b
a
i 1
Ci

2 2 N 2 2 2 N

4 4
1 2 2 N
2 22 N
1
2N 22 N
2 2 N
2
2 2 N 4 4

2N 22 N
22 N 4 2 N 4

4 2N 4
22 N 2 2 N 1

2N 1
 Case 2: A System with One
Retailer and N-1 Supplier
U sum series will become geometric series and after
summing this series by geometric sum;
2
1 N

U (2 2 N
2 22 N
) a Ci ......(20)
4b i 1
System Profit Ratio in Coordinated SC vs. Uncoordinated
SC is

C U 22 N 2 2 N 1
Profit Ratio
U 2N 1
Lot sizing problem with stochastic
demand in a News-vendor
environment
 Coordinated Lot Sizing with
Stochastic Demand in
Newsvendor
Problem Environment
arises when a retailer must make a one-time
purchase of a single product to meet uncertain
demand.

Problem of deciding the size of a single order that

must be placed before observing demand when there
are overage and underage costs.
 Coordinated Lot Sizing with
Stochastic Demand in
Let ONewsvendor Environment
= the overage cost per unit
U = the underage cost per unit
F(Q*)= U/(O+U),
where F(x) = Cumulative distribution function over random
demand X.
Ps & Pr be the price charged by Supplier and Retailer.
Cs & Cr be the manufacturing cost for supplier &
retailers cost per unit
Qc* & Qu* optimal quantity in coordinated and
uncoordinated system respectively.
 Coordinated Lot Sizing with
Stochastic Demand in
Newsvendor Environment
For Uncoordinated SC
If retailer acts independently, its underage and
overage costs are;
U u Pr (Cr Ps ) ...............(21)
Ou Cr Ps V .............(22)

Ratio;
Where V = salvage value of any unsold unit
U u Ou U u Pr (Cr Ps ) Pr V .....(23)
 Coordinated Lot Sizing with
Stochastic Demand in
Newsvendor Environment
For Coordinated SC
And if the firm coordinate in supply chain, the
systems underage and overage costs are;
U c Pr Cr Cs ...........(24)

Oc Cr Cs V ...........(25)
Ratio;
U c Oc U c Pr (Cr Cs ) Pr V .....(26)
 Coordinated Lot Sizing with
Stochastic Demand in
f(x)Newsvendor Environment
is the density function of random demand X.
In independent optimization, total profit (Qu* ) ;
Qu*
(Qu* ) xU u (Qu* x)Ou f ( x)x Qu*U u f ( x )x ( Ps Cs )Qu*
0 *
Qu

Qu*

Pr Cr Cs Qu* ( Pr V ) F ( x)x ........(27)

0
Expected profit:
Q
P Q xU Q x O f ( x )dx QUf ( x)dx
0 Q

f(x) = density function of random demand x

Q Q
P Q x(U O ) f ( x)dx OQf ( x )dx QUf ( x )dx
1 4 42 4 43 1 4 2 43 1 4 2 43
0 (1) Independent of Q 0 2 Q 3

P Q Q
Now 0 O f ( x)dx Uf ( x)dx
Q 0 Q
Q Q

OF Q Uf ( x)dx Uf ( x )dx Uf ( x )dx

*

Q 0 0
Q

OF Q U f ( x)dx U f ( x )dx
*

0 0

P (Q )

OF Q* U UF (Q* ) f ( x )dx 1
Q 0
For maximum Profit:

P (Q)
0
Q
0 OF Q* U UF (Q* )
U
F (Q* )
O U

F(Q*) is the cumulative distribution function over random

demand x.
In case of Un Coordinated
Optimal quantity = Qu*
Underage cost per unit = Uu = Pr-Cr-Ps
Overage cost per unit = Ou = Cr + Ps V
Uu
So F (Q )
*
u
Ou U u

In case of Coordinated
Optimal quantity = Qu*
Underage cost per unit = Uc = Pr-Cr-Cs
Overage cost per unit = Ou = Cr + Cs V
Uc
F (Q )
*
c
Oc U c
 Un coordinated system:
The total profit

Qu*
(Qu* ) 0 u u
* u u
* * *
xU (Q x )Ou f ( x ) x Q U f ( x ) x ( P C )Q
1 s4 2 4 s
3u
1 4 4 4 4 4 4 4 4 2 4 4 4 Q4u 4 4 4 4 3 Supplier profit
Retiler profit

Qu* Qu*
x U u Ou f ( x )x Ou Qu* f ( x )x Qu*U u f ( x )x ( Ps Cs )Qu*
0 0 Qu*

Qu* Qu*
(Qu* ) U u Ou x f ( x )x Qu*Ou f ( x )x Qu*U u f ( x )x ( Ps Cs )Qu*
1 42 43
1 4 4 4 2 4 4 43 14 2 43 1 44Q2
0 0 *
u
4 43 Part 4
Part 1 Part 2 Part 3
Now integrating by parts
du
uvdx u vdx dx
. vdx dx

Qu*

Part-1 U u Ou x f ( x)x
0

Qu* x Qu
Qu* *

U u Ou x f ( x )x . f ( x )x dx
0 0
x 0
Qu*
U u Ou xF ( x) 0 F ( x)dx
*
Qu

0
Qu*

U u Ou Q F (Q ) F ( x)dx
*
u
*
u
0
Qu*

U u Ou Qu* F (Qu* ) U u Ou F ( x)dx

0
 Qu*

Part 2 Ou Qu* f ( x)x

0

Ou Qu* F Qu*

uU u f ( x )x
*
Part 3 Q
Qu*

Qu* Qu*
Q Uu f ( x)x f ( x )dx f ( x )dx
*
u
Qu* 0 0
Qu*
Q Uu f ( x)dx f ( x)dx
*
u

0 0
Qu*U u 1 F (Qu* )
Putting all the value, we get
Qu*

Qu* U u Ou Qu* F (Qu* ) U u Ou F ( x )dx Ou Qu* F (Qu* )

0

U u Qu* 1 F (Qu* ) Ps Cs Qu*

Qu*

U u Ou U u Ou Qu* F (Qu* ) U u Ou F ( x ) dx U Q
u u
*
Ps C s Qu
*

0
Qu*

0 U u Ou F ( x)dx Qu* U u Ps Cs
0
Qu*

U u Ps Cs Qu* U u Ou F ( x)dx
0

putting the value of U u and O u , we get

Qu*

Qu* Pr Cr Cs Qu* Pr V F ( x )dx

0
For coordinated:
The profit

Qc*
(Qc* ) c c
cU c f ( x)x
* *
xU (Q x )Oc f ( x ) x Q
0 Qc*

Qc* Qc*

c c
U O xf ( x ) x c c
Q *
O f ( x ) x cU c f ( x)x
Q *

10 4 44 2 4 4 43 10 44 2 4 43 Qc*
1 44 2 4 43
1 2 3
Now integrating
Part 1 Q *
c

U c Oc xf ( x)x
0

Qc* Qc* x Qc
*

U c Oc x f ( x)x f ( x)x dx
0 0
x 0
Qc*
U c Oc Qc F Qc F ( x )dx
* *

0
Qc*

U c Oc Qc* F Qc* U c Oc F ( x)dx

0

Part 2 Qc*

Qc*Oc f ( x)x
0
Qc*

Qc*Oc
0
f ( x)x Qc*Oc F (Qc* )
Part 3

QU f ( x)x Q U c f ( x )x
* *
c c c
Qc* Qc*

Qc* Qc*
Q Uc f ( x)x f ( x)x f ( x)x
*
c
Qc* 0 0
Qc*
Q Uc f ( x)x f ( x)x
*
c

0 0
Qc*U c 1 F (Qc* )
Thus the profit is
Qc*

U c Oc Qc* F Qc* U c Oc F ( x ) dx Q *
O
c c F Qc
*

Qc*U c 1 F Qc*
Qc*

U c Qc* U c Oc F ( x)dx
0

Putting the value of U c and Oc , we get

Qc*

Qc* Pr Cs Cr Qc* Pr V F ( x)dx

0
Now the profit change due to coordination:
Qc* Qu*
Qc*
Pr Cs Cr Q Pr V F ( x )dx
*
c
0
Qu*
Pr Cr Cs Qu Pr V F ( x)dx
*

0
Qc
*

Pr Cs Cr Qc Qu Pr V F ( x )dx
* *

Qu*
Now
Qc*
Pr V F ( x)dx Pr V Qc* Qu* .F (Qc* )
Qu*
P Cr Cs
Pr V Qc* Qu* r
Pr V
 Qc*
Pr V F ( x)dx Qc* Qu* Pr Cr Cs (let eqn A)
Qu*
Now
Qc*
Pr Cr Cs Q Q Pr V F ( x)dx (let eqn B )
*
c
*
u
1 4 4 44 2 4 4 4 43 Qu*
Part 1 1 4 4 4 2 4 4 43
Part 2

Here Part 2 Part 1, from eqn A

thus 0
This equation proves that profit in coordinated supply chain is always more
than profit of uncoordinated supply chain.

So the coordination always leads to a improved profit

 Coordinated Lot Sizing with
Stochastic Demand in
TheNewsvendor Environment
order size will be increased if there is
coordination between to firms because Cs<Ps.

The suppliers profit increase with joint

optimization, but retailers profits decrease.

Therefore some profit of supply chain should be

redistributed towards the retailer.
 Coordinated Lot Sizing with
Stochastic Demand in
Newsvendor
If demand Environment
is uniformly distributed between a and
b, the expected profit for the uniform distribution
with ordering quantity Q;

1
for a x b
f x ba
0 for other x
.
In case of Coordinated SC
Q b
Pr ofit xU Q x O f ( x)dx QUf ( x )dx
a Q
Q

UQ U O F ( x)
a

Now
x x
1
F ( x) f ( x)dx dx
a a
ba
xa
F ( x)
ba
 Q
xa
Q QU U O dx
a
ba
U O Q Q

QU xdx adx
b a a a
U O x
2 Q
QU a Q a
b a 2 a

U O Q 2 a 2
QU aQ a
2

ba 2
U O Q2 a 2
Q QU aQ (let eqn c )
ba 2 2
For optimal condition
U
FQ
*

O U
Q* a U

b a O U
U b a
Q a
*

O U
Now putting the value of Q* in equation c, we get
b-a U 2

(Q* ) =aU+
2 U+O
 Example: Lot Sizing with
Stochastic Demand in
ForNewsvendor
Numerical example:Environment
In this example we can use MS Excel commands
to solve this problem.

Commands involved in MS Excel for solving this

problem are;
NORMSDIST
NORMDIST
NORMINV
 Derivation of formulas used in profit
calculations when doing numerical examples.
 For coordinated case
Q
xU Q x O f ( x)dx QUf ( x )dx
Q

Q Q
Q Q

O U xf ( x)dx QO f ( x )dx QU f ( x )dx f ( x )dx f ( x )dx

Q
Q Q
Q

O U xf ( x)dx QO f ( x )dx QU f ( x )dx f ( x )dx

Q Q

O U xf ( x)dx Q O U f ( x )dx QU ___(let eq D )

Let demand density function normally distributed with mean ,
standard deviation

So x
2

1
f ( x)dx e 2 2

x
let z

dz dx
Now putting the value of f(x) and dx in equation D, we get
Q Q

O U xf ( x)dx Q O U f ( x )dx QU
{
1 4 44 2
4 4 43 1 4 4 4 2 4 4 43 3
1 2

Part 1
Q
z*
1 z2
O U xf ( x)dx O U ( z ) e 2
dz
2
z*
1 z2
O U ( z ) e 2
dz
2
z*
1 z2 z*
1 z2
O U e 2
dz z e 2
dz
2 2
1
z* z2
O U Fs ( z ) *
ze 2
dz
2
 Now
The
z* z2

ze

2
dz

z2
let w
2
dw zdz
2
1 Q

2
1 Q
2 e dz f s
w

So thePart 1
O U Fs ( z * ) f s ( z * )
Part 2
Q

Q (O U ) f ( x)dx

z* z2
1
Q (O U ) e 2
dz
2
Q (O U ).F ( z )
Thus the total profit

part1 part 2 part 3

O U Fs ( z * ) f s ( z * ) Q(O U ).Fs ( z * ) QU
Q* Q*
O U NORMSDIST NORDIST , 0,1, 0

Q*
Q O U .NORMSDIST
*
Q *
U

Numerical Example

Uncoordinated and coordinated supply chain:

1. Demand function is normally distributed

2. Demand function is uniformly distributed between a to b.
Example 1

Demand is normally distributed.

Mean () = 1000 units
Standard deviation() = 500 unit
Supplier manufacturing cost (Cs)= $20
Retailer supplier cost (Cr) = $20
Retailer price of product (Pr) = $100
Price charged by supplier (Ps) = $50
Product salvage value V = $10
Solution:
Uu = Pr Cr Ps = 100-20-50 =$30
Ou = Pr Cr Ps = 20 + 50 - 10 = $60
Uc = Pr Cr Cs = 100 20 20 =$60
Oc = Cr + Cs V = 20+20-10 =30
Uu 30 1
F (Q )
*
u 0.333
Ou U u 30 60 3
Using Excel
Qu*= NORMINV(1/3, 1000,500) = 784.63= 785
Using table, in cumulative std. normal , z value corresponding to
(FQu*=0.333) is -0.43
Qu*
z

Qu* 1000
0.43
500
Qu* 785
Now in case of uncoordinated
Retailer Profit
Q

xU u Q x Ou f ( x )dx QU u f ( x )dx
Q
x
1
using f ( x) e 2 2

2
x
z

Finally we will reach to the following formula
= O u U u Fs ( z ) f s ( z * ) Q* O u U u Fs z * Q*U u
Q* Q*
O u U u NORMSDIST NORMDIST

Q*
Q Ou U u .NORMSDIST
*
Q Uu
*

Q* Q*
Note here F = Cumulative distribution function =NORMSDIST

 f s ( z * ) StandardNormaldistributionfunction
Q*
NORMDIST

1
z2

fs z

*
e 2
2

Now
Q* = 785
Q*
z
*

785 1000
0.43
500

So
Fs ( z * ) NORMSDIST ( z * ) 0.333598
f s ( z * ) NORMDIST ( z * ) 0.363714
So
U = (30+60) [1000*0.333598 500*0.3]-
785*(60+30)*0.333598+783*30
= $13638 ( Retailer profit )

Supplier profit = (Ps - Cs)Q* = (50 - 20)*785 = 23550

Total channel profit = Retailer profit + Supplier profit

= 13638 + 23550 = $37188
For Coordinated
Uc 60 2
F Q*
O U 60 30 3
Using Excel

Q* NORMINV 2 ,1000,500 1215
3
Using table, z value corresponding to [F(Q*)=2/3 is 0.43.
So
Q*
z

Q* 1000
0.43
500
Q* 1215
Similarly in case of profit formula for channel,

T Oc U c Fs ( z * ) f s ( z * )
Q* Oc U c Fs ( z * ) Q*U c
For calculation in Excel
T Oc U c NORMSDIST ( z * ) NORMDIST ( z * )
Q* Oc U c NORMSDIST ( z * ) Q*U c
1215 1000
Now z *
0.43
500
T = (60+30)[1000 NORMSDIST(0.43)- NORMDIST(0.43)]
- 1215 (60+30) NORSDIST(0.43) + 1215*60

T = $43579

Now = c- U = 43579 37188 = $6391

% Increase in profit due to coordination

= (6391/37188)*100 = 17.18%
If the demand is uniformly distributed between 5000 to 15000
unit.
Case 1: Uncoordinated
a = 5000, b= 15000
Uu = $30 Ou = $60

Uu
Q a (b a )
*

U u Ou
30
5000 (15000 5000)
30 60
Q* 8333units
So retailer profit:

b a U u2
Uu a
2 U u Ou
15000 5000 30 2
30 5000
2 30 60
$200000
Supplier profit =
( Ps Cs ) * Qu* = (50 - 20) * 8333 = $249990

Total channel profit

= retailer profit + supplier profit = $200000 +$249990 = $449000
Case- II: Coordinated
Uc = $60, Oc = $30

Q* = 5000 + (15000 - 5000) * [60 / (30+60)] = 11667 units

b a c
U 2

Total profit U c a
2 Oc U c
15000 5000 602
5000 60 $500000
2 60 30
So change in profit

= c- u = $500000 - $449000 = $51000

% increase (due to coordination in Supply Chain)

= ( / u)*100 = (51000/449000)*100 = 11.35%
Summary
InInSCM,
supply
thechain
actions
management,
of rational managers
communication
of firms
and
coordination can
independently greatly
create enhance
natural the effectiveness
inefficiencies.
of Supply Chain.
By coordination and communication we can
reduce
Throughthese inefficiencies.
coordination we can improve total profit
of supply chain management, inventory control,
As with any group of entities, when all member
pricing control and demand forecasting.
effectively integrated their efforts, synergies may
emerge and SC profit also increase.