International Operations Management MGMT 6367 Lecture 04 Instructor: Yan Qin Fall 2013

Outline – Supply Chain Management Push, Pull, and Push-Pull systems Distribution Strategies Design for Supply Chain efficiency Supply Chain Contracts Buy Back contracts Quantity Discount s More Supply Chain contracts Cycle inventory

Push-based Supply Chain In a push-based supply chain, production and distribution decisions are based on demand forecasts. Products are pushed from upstream to downstream. MRP (Materials Requirements Planning): which involves production planning and inventory control. MRP II (Manufacturing Resource Planning): MRP is just one part of MRP II. MRP II also includes activities such as financial planning, cost reporting, production floor planning.

Pull-Based Supply Chain In a pull-based supply chain, production and distribution are demand driven so that they are coordinated with true customer demand rather than forecast demand. The implementation of a Pull system requires efficient information sharing among supply chain members. Whether a supply chain is operated as a push or pull-based supply chain depends on what kind of demand info is used as inputs. What is a lean supply chain?

Push Vs. Pull Response time to changes in demand Area Push system Pull system Response time to changes in demand Slow, may lead to lost sales when there is upturn and inventory obsolescence when demand drops Quick, demand driven Product customization Difficult Relatively easy Demand Variability to upstream members High Low Inventory level Low (no inventory in a pure pull system) Economies of scale Yes Often difficult due to small batches Implementation Easy, just build inventory due to bullwhip effect

Push-Pull Supply Chain In a push-pull system, some stages of the supply chain, usually the initial stages, such as supplier and manufacturer, are operated in a push-based manner while the remaining stages employ a pull-based strategy. A push-pull system is usually designed to avoid the long production lead time in the pull situation and the inability of responding to changes in demand in the push situation. Postponement can be a good example. HP’s DeskJet printers are customized at the distribution centers based on demand, rather than at the factories. The production of the printers is push-based to avoid the long lead time and the variability in production scheduling but the final assembly is pull-based in response to a specific customer request.

Distribution Strategies Three common outbound distribution strategies: Direct shipment: Products are shipped directly from supplier to the retail stores. Warehousing: Classical strategy in which warehouses keep stock and fulfill orders from the retailer. Cross-docking: Products are distributed continuously from suppliers through warehouses to customers. But the warehouse rarely keep the products for more than 10 to 15 hours.

Direct Shipment Direct shipment is common for large retailers, which requires fully loaded trucks. Advantages Disadvantages Avoid of the expense of operating a distribution center Higher transportation costs if shipments are small and the supplier serves a number of retailers Reduced lead time Many suppliers set up warehouses to serve smaller retailers and use direct shipment with large retailers.

Cross-docking In cross-docking, the warehouse is used as an inventory coordination point rather than as an inventory storage point. The implementation of cross-docking requires: A significant start-up investment; Retailers and suppliers must be linked with advanced information systems, such as at Wal-Mart. A fast and responsive transportation system. Effective only for large distribution systems in which a large number of vehicles are delivering and picking up at any one time.

Design product for Supply Chain efficiency Product design used to be an independent function isolated from manufacturing and logistics. Design for manufacturability (DFM) movement: The link between product design and manufacturing was established out of the need to know why products fail and how to minimize the failure. It was recognized that product reliability is closely linked with product design. DFM is also called concurrent engineering

Design product for Supply Chain efficiency Design for Logistics (DFL) Innovative product designs appear that take logistics considerations into account. Two significant ways that logistics considerations enter into product design phase: Product design for efficient transportation and shipment Delayed differentiation to take advantage of benefits such as economies of scale. Firms recently realized that logistics can have as much an impact as manufacturing and product design. (Example: Furniture sold in simple-to-assemble kit, usually packed for easy storage and shipment)

Allocation of Supply Chain Profits With respect to the allocation of supply chain profit, firms should care about two things: The size of a firm’s piece of the “pie”, where the pie refers to the supply chain’s total profit; The size of the total “pie”. A classic tension within a supply chain: An increase in one firm’s profit might come at the expense of a decrease in the other firm’s profit. Local optimization What a supply chain needs is a tool that first maximizes the size of the “pie” and then allows them to decide how to divide it between them. Such a tool can be Buy-Back contracts.

Buy-back Contracts Buy-back contracts introduce new costs into the supply chain since the original buyer will need to ship the leftover inventory back to the original supplier. Buy-back contracts may also generate new revenue as the supplier may be able to resell the leftover to another buyer, possible at another location. What can be some other possible reasons for a supplier to accept returns from a buyer? Share the risks of demand uncertainty. A company may wish to accept returns to protect its brand image. End-of-season markdowns When there are multiple retailers, the supplier may be able to redistribute the inventory among them. The supplier sometimes accept returns to signal to retailers that it is not about to introduce a new product that makes the current product obsolete. To signal that it will commit significant marketing effort to the market. To build a strong relationship with its retailers.

More Supply Chain Contracts Three common-type of quantity discount supplier pricing: Linear Quantity Discount This quantity discount scheme assumes that a supplier offers a price that decreases in the quantity ordered by a retailer. Let t be some constant discount rate and 𝑣 𝑓 be the base price. Unit price for order quantity Q: 𝑣 𝐿𝐷 𝑄 = 𝑣 𝑓 −𝑡×𝑄

Linear Quantity Discount When the total purchasing cost is concerned, as we can see from the right figure, the total purchasing cost keeps increasing until Q = v/(2t) and decreases since then. What it means is that for order quantities that exceed v/(2t), the more you order, the less you pay in total. A linear discount scheme usually has the limitation on how much a buyer can order at maximum.

All-unit Quantity Discount The unit price offered by a supplier declines on a step function basis. Define 𝑣 𝑖 as a set of alternative unit prices such that 𝑣 1 > 𝑣 2 >⋯> 𝑣 𝑛 And let 𝑞 𝑖 be a set of quantities, called break points, such that 𝑞 1 < 𝑞 2 <⋯ 𝑞 𝑛 Set 𝑞 0 =0. Then the all-unit quantity discount can be expressed as 𝑣 𝑖 𝑓𝑜𝑟 𝑞 𝑖−1 <𝑄≤ 𝑞 𝑖 , 𝑓𝑜𝑟 𝑖=1,2,3…

All-Unit Quantity Discount Unit cost As we can see from the left figure, the unit cost/price applies to all the units purchased and decreases as the order quantity increases. Do you see anything irrational here? the total cost of ordering 𝑞_2 units is higher than the total cost of ordering slightly more than 𝑞_2 units. This is an incentive for buyers to order more.

Incremental Quantity Discount Under incremental quantity discounts, discounts are only applied to additional units beyond the breakpoints. The unit cost/price 𝑣 𝑖 for the quantity interval ( 𝑞 𝑖−1 , 𝑞 𝑖 ] decreases as 𝑖 increases. The average unit cost/price can be calculated as follows: 𝑣 1 𝑓𝑜𝑟 0<𝑄≤ 𝑞 1 , 𝑣 1 𝑞 1 + 𝑣 2 (𝑄− 𝑞 1 ) 𝑄 for 𝑞 1 <𝑄≤ 𝑞 2 𝑣 1 𝑞 1 + 𝑣 2 𝑞 2 − 𝑞 1 + 𝑣 3 (𝑄− 𝑞 2 ) 𝑄 for 𝑞 1 <𝑄≤ 𝑞 2 The unit discounted price is just the total purchase cost divided by the order quantity.

Example Suppose a trash bag company charges based on an incremental scheme. Specifically, it charges 30 cents per bag for the first 500 bags, 29 cents for all units beyond. Then for orders of no more than 500 bags, what is the average cost? For orders of less than 1001 bags but more than 500, what is the average cost?

Incremental Quantity Discount As we can see from the left figure, discounts are only applied to the additional units beyond those break points. The average unit cost/price decreases as the order quantity increases due to the discounts. Different from the all-unit schedule, no irrationality is observed in the right figure. The total purchasing cost increases as the order quantity increases.

Example: Quantity Discount Suppose a store has been given an all-unit quantity discount schedule for a product. The normal cost for the product is $5. For orders between 1001 and 2000 units, the unit cost drops to $4.8; for orders of 2001 or more units, the unit cost is only $4.75. The store expect the sales for that product in the next month to be 2500. How much does it pay? Now how much does the store pay if it is offered an incremental quantity discount scheme with the same quantity break points as stated above. The price is $5 for orders no greater than 1000. For the next additional 1000 units, the unit price becomes $4.8. For any additional units above 2000, the price drops to $4.75. What is the purchasing cost?

Comments: Note that the average cost/price per unit with an all-unit schedule will be less than the average cost per unit with the corresponding incremental schedule. Notice the irrationality of the all-unit schedule? In the example, 1,000 units would cost $5,000, whereas 1,001 units would only cost $4,804.8. This is an incentive for a buyer to purchase more.

More Supply Chain Contracts Options Contracts With an options contract, a buyer pays a price to purchase options and another price to exercise the purchased options. Revenue Sharing With revenue sharing, a buyer pays a wholesale price to the supplier but then also pays a portion of the revenue earned. It is used when a buyer wants a supplier to build excess capacity well in advance of the selling season. The second price is not paid until the excess capacity is actually used. As with options contract, revenue sharing contracts allow supply chain member to share the risk resulted from demand uncertainty.

More Supply Chain Contracts Quantity Flexibility Contracts Suppose a buyer and a supplier agree upon a 25% Quantity Flexibility Contract. Price Protection With price protection, a supplier compensates the buyer on remaining inventory for any price reduction. The buyer informs the supplier that its demand forecast for next year is 2000. Then the buyer is committed to buy 75% of the 2000. And the supplier is committed to shipping 125% of the 2000 if the buyer needs.

Green Supply Chain A fully developed green supply chain considers sustainability for every participant at every step, from product design to production, transportation, storage, consumption, to eventual disposal or recycling. The objective is to reduce waste, mitigate legal and environmental risks, minimize or eliminate adverse health impacts, improve the reputations of companies and their products, and enable compliance with increasingly stringent regulations and societal expectations. Green supply chains (GSCs) became Supply Chain Digest’s No. 1 supply chain trend in 2007 as more companies such as Wal-Mart embraced them. In a conventional supply chain, as the product moves from design to consumption, problems such as unfair wages, deforestation, or air pollution accrue and these costs may not be reflected in the price of the finished product. The costs, instead, are usually externalized to the public in some fashion. A green supply chain, however, internalizes some of those costs

Next: Cycle Inventory We will next discuss How to choose the optimal lot size and cycle inventory to minimize the related costs in a supply chain using the Economic Order Quantity model; and Quantify the impact of quantity discounts on lot size and cycle inventory. (We will focus on the impact of all-unit discounts in this class.)

Cycle Inventory A lot or batch size is the quantity that a stage of a supply chain either produces or purchases at a time. Cycle inventory is the average inventory in a supply chain due to either production or purchases in lot sizes that are larger than those demanded by the customer. Example: A computer store that sells an average of 4 printers a day. The store manager orders 80 printers from the manufacturer each time he places an order. Then the lot or batch size is 80 printer.

Let’s start with the simplest situation… Suppose (1) there is no uncertainty in demand and (2) order lead time is zero. For effective inventory control in this overly simplified situation, Ford W. Harris introduced the Economic Lot Size model, or Economic Order Quantity (EOQ) model, in 1915. The EOQ model illustrates the tradeoff between the setup cost and inventory holding cost. That is, demand is known ahead of the selling season. The minute you place an order, the minute you receive the order.

EOQ Model Three types of costs are considered in the EOQ model: Purchasing cost per unit, that is, selling price, denoted as C Setup cost, which is the fixed cost incurred by order placement, denoted as K (aka, ordering cost) Inventory holding cost per unit per year, denoted as h The objective is to minimize the sum of the three types of costs on an annual basis.

EOQ Model Let D denote the annual demand and Q denote the order quantity. Then the total annual cost can be expressed as 𝑇𝐶=𝐷×𝐶+𝐾× 𝐷 𝑄 +ℎ× 𝑄 2 Annual Purchasing Cost Annual Setup cost K is the fixed setup cost per order. And 𝐷/𝑄 is the number of orders to place in a year if Q units are ordered each time. Annual Inventory holding cost The average inventory level is Q/2 since demand is constant and the minimum inventory level is 0 and the maximum is Q. The notation h is the inventory holding cost per unit per day.

Economic Order Quantity Using a little calculus, the order quantity that minimizes the total annual cost is 𝑄 ∗ = 2𝐾𝐷 ℎ The optimal order quantity, aka economic order quantity, increases as the setup cost K increases. That is, a larger order will be placed when it is expensive to place an order. The optimal order quantity decreases as the inventory holding cost increases so as to reduce

Cycle Inventory under EOQ model When demand is steady, cycle inventory and lot size are related as follows: Cycle inventory = 𝐿𝑜𝑡 𝑠𝑖𝑧𝑒 2 = 𝑄 2 Therefore, under the EOQ model, 𝑄 ∗ 2 is the optimal cycle inventory level that minimizes the total cost.

Example: EOQ & Cycle Inventory Consider a hardware supply warehouse that is contractually obligated to deliver 52,000 units of a fastener to a local manufacturer in a year. Each time the warehouse places an order from its suppliers, an ordering and transportation fee of $20 is charged. The warehouse pays $1 per each fastener. Annual inventory holding cost is 25% of the unit inventory value, or $0.25 per year. The warehouse manager would like to know how much to order each time when the inventory gets to zero. And what is the resulted cycle inventory level?

Impact of quantity discounts We now consider pricing schedules that encourage buyers to purchase in large lots. The buyer’s objective is to select lot sizes to minimize the total annual material, order, and holding costs when given a quantity discount. The impact of all-unit quantity discount on cycle inventory and the optimal response of a retailer (the buyer) when faced with an all-unit quantity discount will be discussed.

Find the optimal lot sizing response To find the optimal lot size under an all-unit quantity discount, we need to evaluate the optimal lot size for each price and pick the one that minimizes the overall cost. Step 1: Evaluate the optimal lot size for each price, 𝑣 𝑖 , as follows. 𝑄 𝑖 = 2𝐷𝑆 ℎ 𝑣 𝑖

Find the optimal lot sizing response Step 2: We next select the order quantity 𝑄 𝑖 * for each price 𝑣 𝑖 . There are three possible cases for 𝑄 𝑖 : 𝑞 𝑖−1 ≤ 𝑄 𝑖 ≤ 𝑞 𝑖 𝑄 𝑖 < 𝑞 𝑖−1 𝑄 𝑖 > 𝑞 𝑖 Case 3 can be ignore, since it is for 𝑄 𝑖+1 . In Case 1, we set 𝑄 𝑖 ∗ = 𝑄 𝑖 ; In Case 2, we set 𝑄 𝑖 ∗ = 𝑞 𝑖−1 to take advantage of the quantity discount.

Find the optimal lot sizing response Step 3: For each 𝑄 𝑖 ∗ , calculate the resulted total annual cost as follows: Total cost, 𝑇𝐶 𝑖 = 𝐷 𝑄 𝑖 ∗ 𝐾+ 𝑄 𝑖 ∗ 2 ℎ 𝑣 𝑖 +𝐷𝐶 Step 4: Select the 𝑄 𝑖 ∗ with the lowest total cost.

Example: EOQ under all-unit discount The demand for a product is 10,000 bottles per month. The fixed ordering cost incurred at the buyer’s place is $100 per order and the inventory holding cost is 20%. The seller uses the following all unit discount scheme. What is the optimal order quantity or lot size in this case? Quantity breaks Unit Price 0 – 4,999 $3.00 5,000 – 9,999 $2.96 10,000 and more $2.92

Next Week Production Facility Layouts Basic production Layouts Suitable products for each layout Design of Process Layout CRAFT Systematic Layout Planning Design of Assembly Line Assembly line balancing How to speed up