Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Chapter 12 Determining the Optimal Level of Product Availability

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Outline uThe importance of the level of product availability uFactors affecting the optimal level of product availability uManagerial levers to improve supply chain profitability uSetting product availability for multiple products under capacity constraints uSetting optimal levels of product availability in practice

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Importance of the Level of Product Availability uProduct availability measured by cycle service level or fill rate uAlso referred to as the customer service level uProduct availability affects supply chain responsiveness uTrade-off: –High levels of product availability increased responsiveness and higher revenues –High levels of product availability increased inventory levels and higher costs uProduct availability is related to profit objectives, and strategic and competitive issues (e.g., Nordstrom, power plants, supermarkets, e-commerce retailers) uWhat is the level of fill rate or cycle service level that will result in maximum supply chain profits?

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Factors Affecting the Optimal Level of Product Availability uCost of overstocking uCost of under stocking uPossible scenarios –Seasonal items with a single order in a season –One-time orders in the presence of quantity discounts –Continuously stocked items –Demand during stock out is backlogged –Demand during stock out is lost

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Managerial Levers to Improve Supply Chain Profitability uObvious actions –Increase salvage value of each unit –Decrease the margin lost from a stockout uImproved forecasting uQuick response uPostponement uTailored sourcing

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Improved Forecasts uImproved forecasts result in reduced uncertainty Less uncertainty (lower R ) results in either: –Lower levels of safety inventory (and costs) for the same level of product availability, or –Higher product availability for the same level of safety inventory, or –Both lower levels of safety inventory and higher levels of product availability An increase in forecast accuracy decreases both the overstocked and understocked quantity and increases a firms profits.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Impact of Improving Forecasts (Example) Demand: Normally distributed with a mean of R = 350 and standard deviation of R = 100 Purchase price = $100 Retail price = $250 Disposal value = $85 Holding cost for season = $5 How many units should be ordered as R changes?

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Impact of Improving Forecasts

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Quick Response uSet of actions taken by managers to reduce lead time uReduced lead time results in improved forecasts –Typical example of quick response is multiple orders in one season for retail items (such as fashion clothing) –For example, a buyer can usually make very accurate forecasts after the first week or two in a season –Multiple orders are only possible if the lead time is reduced – otherwise there wouldnt be enough time to get the later orders before the season ends uBenefits: –Lower order quantities less inventory, same product availability –Less overstock –Higher profits If quick response allows multiple orders in the season, profits increase and the overstock quantity decreases.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Quick Response: Multiple Orders Per Season uOrdering shawls at a department store –Selling season = 14 weeks –Cost per handbag = $40 –Sale price = $150 –Disposal price = $30 –Holding cost = $2 per week uExpected weekly demand = 20 uSD of weekly demand = 15

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Impact of Quick Response

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Forecast Improves for Second Order (SD=3 Instead of 15)

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Postponement uDelay of product differentiation until closer to the time of the sale of the product uAll activities prior to product differentiation require aggregate forecasts more accurate than individual product forecasts uIndividual product forecasts are needed close to the time of sale – demand is known with better accuracy (lower uncertainty) uResults in a better match of supply and demand uValuable in e-commerce – time lag between when an order is placed and when customer receives the order (this delay is expected by the customer and can be used for postponement) uHigher profits, better match of supply and demand Postponement allows a firm to increase profits and better match supply and demand if the firm produces a large variety of products whose demand is not positively correlated and is of about the same size.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Value of Postponement: Benetton uFor each color –Mean demand = 1,000; SD = 500 uFor each garment –Sale price = $50 –Salvage value = $10 –Production cost using Option 1 (long lead time) = $20 –Production cost using Option 2 (uncolored thread) = $22 uWhat is the value of postponement? –Expected profit increases from $94,576 to $98,092

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Value of Postponement with Dominant Product uColor with dominant demand: Mean = 3,100, SD = 800 uOther three colors: Mean = 300, SD = 200 uExpected profit without postponement = $102,205 uExpected profit with postponement = $99,872

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Tailored Postponement: Benetton uProduce Q 1 units for each color using Option 1 and Q A units (aggregate) using Option 2 uResults: – Q 1 = 800 – Q A = 1,550 –Profit = $104,603 uTailored postponement allows a firm to increase profits by postponing differentiation only for products with the most uncertain demand; products with more predictable demand are produced at lower cost without postponement

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Tailored Sourcing uA firm uses a combination of two supply sources uOne is lower cost but is unable to deal with uncertainty well uThe other is more flexible, and can therefore deal with uncertainty, but is higher cost uThe two sources must focus on different capabilities uDepends on being able to have one source that faces very low uncertainty and can therefore reduce costs uIncrease profits, better match supply and demand

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Tailored Sourcing uSourcing alternatives –Low cost, long lead time supplier »Cost = $245, Lead time = 9 weeks –High cost, short lead time supplier »Cost = $250, Lead time = 1 week

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Tailored Sourcing Strategies

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Tailored Sourcing: Multiple Sourcing Sites

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Dual Sourcing Strategies

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Setting Product Availability for Multiple Products under Capacity Constraints uSingle product order uMultiple product order uDecrease the order size uAllocating the products When ordering multiple products under a limited supply capacity, the allocation of capacity to products should be based on their expected marginal contribution to profits. This approach allocates a relatively higher fraction of capacity to products that have a high margin relative to their cost of overstocking.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Setting Optimal Levels of Product Availability in Practice uUse an analytical framework to increase profits uBeware of preset levels of availability uUse approximate costs because profit-maximizing solutions are very robust uEstimate a range for the cost of stocking out uEnsure levels of product availability fit with the strategy

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Strategic Capital Assets Maintenance Support MRO inventory policies in support of Strategic Capital Assets are governed by stochastic, economic and sourcing considerations. How can companies and organisations holding such assets ensure minimal downtimes while keeping inventory carrying and obsolescence costs under control?

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Summary of Learning Objectives uWhat are the factors affecting the optimal level of product availability? uHow is the optimal cycle service level estimated? uWhat are the managerial levers that can be used to improve supply chain profitability through optimal service levels? uHow can contracts be structured to increase supply chain profitability?