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Chapter 13

Quick Response with Reactive Capacity


Learning Objectives for Chapter 13

Cost of mismatch between demand and supply


Added accuracy in demand leads to better
capacity management
Demand information closer to season provides
more accuracy
How to plan the additional capacity, based on
the more accurate demand forecast

PROD 529: Chapter 13 2


Mismatch Cost

Mismatch Cost = CO * Expected Left over I + CU * Expected Lost Sales

This cost increases when demand variability is


high
Since the possibility of demand is spread over a
larger range
So both lost sales and left over inventory is high
This cost increases when critical ratio is low
Since overage cost is high, one would tend to order
less lost sales would be higher

Cu
F (Q)
Co Cu
PROD 529: Chapter 13 3
Example, CR, CV, Mismatch
Cu Co

Loss due to
Margin, $ Coefficient of
Product salvaging, $ CR
per unit variation
per unit
Lowest
Snow 900 100 0.2 0.90
Ice 1600 400 0.25 0.80
Freeze 100 200 0.85 0.33 Highest

Blizzard 500 1000 0.4 0.33


Powder 400 100 0.25 0.80
Chill 800 200 0.2 0.80

PROD 529: Chapter 13 4


Manufacturing Strategies and Matching
Demand and Supply: MTO
Make to order: Production is initiated after the
order (and quantity) is known
This minimizes mismatch (to 0)
However, wait time for customers is long
Especially true if utilization is high (remember, from Chapter
8?)
So the issue becomes, how much utilization are you willing to
sacrifice to reduce the wait time

PROD 529: Chapter 13 5


Manufacturing Strategies and Matching
Demand and Supply: ATO
Assemble to order: Postpone assembly of final
product after the order (and quantity) is known
This minimizes mismatch (to 0)
However, implies that we know how much and hold
inventory of the components and subassemblies
Postponement - link to delayed differentiation in Chapter 15

PROD 529: Chapter 13 6


Manufacturing Strategies and Matching
Demand and Supply: MTS
Make to stock: Production happens before
actual demand happens
Highest level of mismatch
How might these concepts apply to the
Hamptonshire Express case?

PROD 529: Chapter 13 7


Reactive Supply & Manufacturing Strategy

MTS Commit supply (capacity) before demand


occurs
MTO Commit supply after demand occurs
What is in between?
Commit some supply before demand happens
With option of additional capacity after observing
some of the demand
This additional capacity is called Reactive Capacity

PROD 529: Chapter 13 8


Unlimited Reactive Capacity

Place first order based on demand forecast


Similar to the newsvendor problem

Place second order based on observed demand


for portion of the season
Assumptions to help us simplify the decisions
No lost sales before second order is placed
Observing the initial sales gives ability to perfectly
predict the sales for rest of the season

PROD 529: Chapter 13 9


Figure 13.1
Unlimited Reactive Capacity
CU
Step 1: Find critical ratio: CU + CO
Step 2: Find corresponding z value
Q - m
Step 3: Find the first order quantity using: z =
s
Step 4: Find second order quantity by calculating
expected lost sales: Q1 m
s * L(z), where z =
Performance measures: s
Expected sales = m expected lost sales
Expected inventory = Q expected sales
Expected profit = Maximum profit (Co *Expected left over
inventory + Cu *Expected lost sales)
Notice, left over inventories are lower with reactive
capacity, and profit is higher
PROD 529: Chapter 13 11
Example Problem

Zazz, a maker of a hot new MP3 player, is concerned about the availability of flash
memory chips, a key component in the Zazz3 player.
Zazz expects that demand for chips in July is normally distributed with a mean of
250,000 and a standard deviation of 200,000.
It is the start of April and Zazz must commit to a flash memory chip quantity for
delivery in July. Each chip ordered now will cost Zazz $40.
If Zazzs demand in July exceeds its regular order (the amount ordered in April) then
Zazz can obtain additional units on the spot market. The spot market price for these
chips in July is estimated to be $50.
Chips not used in July will certainly be used in August. However, chips ordered in
May for August delivery are expected to cost $36. Furthermore, there is a $1 cost to
hold each chip from one month to the next (due to the opportunity cost of capital and
physical storage costs).
How many chips should Zazz order in April?
How many chips are expected to be bought on the spot market?

PROD 529: Chapter 13 12


Regular cost = $40; spot market price = $50;
May order for August = $36; inventory cost = $1
Mean = 250,000; s.d. = 200, 000
Cu = $50 - $40 = $10 Co = $40 + 1 - $36 = $5 CR = 10/(10+5) = 0.667

First order quantity, Q1 = m + zs = 250000 + .44*200000 = 338000 players F(.43) = .6664; F(.44) = .67;
So z = 0.44

Second order quantity, Q2 =Expected lost sales: Q2 = s*L(z) z = (338000 250000)/200000 = 0.44

L(z) = 0.2169

Q2 = s*L(z) = 200000*.2169 = 43380 players

PROD 529: Chapter 13 13


Limited Reactive Capacity Tug-of-war article

It is hard for suppliers to plan for an unlimited capacity to meet


the second order, especially with short lead time
Need to place restriction on the orders
Too expensive to meet an unlimited order (high cost of meeting
increased capacity)
So require the first order to be a minimum % of total order

Retailers pre-book sales before the start of the season


The pre booked orders is another data point for demand forecast
Company uses this pre-booked inventory to place orders from the
supplier before the season begins
It doesnt then make sense to make two orders for each item
Identify which items are ordered on the first round based on the
mismatch-quantity ratio (lower is better), up to the minimum total order
required
The others items are placed on the second order
Company places another order later, but before the season
PROD 529: Chapter 13 14
Managerial Implications

Need to estimate uncertainty in demand


Need to reduce uncertainty
Flexibility of processes
Supplier relationships

PROD 529: Chapter 13 15

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