1. OMG 402 - Operations Management Spring 1997 CLASS 13: Introduction to Logistics Harry Groenevelt

2. 2 Agenda Introduction Service supply chains One-period decisions Supply chains in the apparel industry (Sport Obermeyer) Conclusions

3. 3 Introduction: Some Vocabulary Logistics: procurement and distribution of material and information; Supply Chain Management: effectively integrating the production and distribution of products or services. Firms form competing supply chains which provide most value to customers at lowest cost.

4. 4 customers Introduction: Generic Supply Chain suppliers manufacturer distributors retailers Supplier Plant Warehouse RRR RRR RRR

5. 5 Introduction Demand for Logistics Support is Growing. Why? –new technologies for monitoring and management –global sourcing, multi-site and international manufacturing –demand for localization and customization

6. 6 Introduction Managers balance the cost of the supply chain and the quality of products and services Major components of cost: –on-hand inventory –transportation and handling costs Measures of quality: –order fill rate (% of time product available when needed) –order lead time (time between order receipt and product delivery) –return rate (% of products returned because of defects, damage, errors in order processing, etc.)

7. 7 Q: What places us on Curve A or Curve B? Q: What is the function of the on-hand inventory? Curve A Curve B Order Fill Rate 0%100% On-hand Inventory (weeks of supply) 0 10 Introduction: Balancing Cost and Quality

8. 8 Supply Chain Management for Services Information and Material Flow Inventory Capacity information indistinguishable from product delivery channel indistinguishable from product product changes significantly along each step of the chain (value-added) the customer can be a ‘co-producer’ when inventory is impossible to hold, excess capacity and flexibility are crucial. in some services, high variability means high inventory in others, inventory is impossible to hold.

9. 9 Logistics for Services: The Role of Inventory –Inventory costs can be significant (consider retail sales, hospitals, aircraft maintenance) –High variability makes stocking decisions difficult; poor decisions have a tremendous impact on customer service Example:L.L. Bean plans production for a new teal turtleneck …

10. 10 Uncertain demand and perishable product Order must be placed before demand is known If not sold immediately, must liquidate Decision: determine commitment quantity One-Period Decisions Probability Density Demand for the turtleneck

11. 11 One-Period Decisions Define: (random) demand for the turtleneck (d) commitment quantity (Q) (not the EOQ!) Q: What factors influence the commitment quantity?

12. 12 One-period Decisions: Commitment Quantity Trade-offs contribution margin or ‘gain’ (G) = opportunity cost of a lost sale (= $15 for teal turtleneck) liquidation cost or ‘loss’ (L) = cost of excess inventory (= $5 for teal turtleneck)

13. 13 One-Period Decisions Demand distribution [assumed Normal with  = 10,000,  = 2,000]

14. 14 One-Period Decisions E[Profit] = E[Total Gain] – E[Liquidation Loss]

15. 15 One-Period Decisions Expected Total Gain rises as we increase the number ordered (Q). It reaches a limit at $150,000. Why? Expected Liquidation Loss rises as we increase the number ordered (Q). Is there any limit on the loss? Why? Expected Profit is maximized between 11,000 and 12,000. Is there an analytical method for finding the optimal Q?

16. 16 outcome value probability sold not sold (liquidate) Buy Qth Turtleneck What is expected value of Qth turtleneck? One Period Decisions Decide how many to buy, given a forecast distribution for random variable d

17. 17 One Period Decisions expected marginal gain from Q th item = (contribution margin) · Pr{Q th item is sold} = G · Pr{d  Q} = G · [1–Pr{d < Q}] expected marginal liquidation loss from Q th item = (liquidation cost) · Pr{Q th item is not sold} = L · Pr{d < Q} buy Q as long as expected value > 0: G · [1– Pr{d 0 or Pr{d < Q} < G/(L+G)

18. 18 Note: relationship between uncertainty and inventory! One Period Decisions: The Solution Example: G = $15, L = $5, d ~ Normal(10000, 2000) Pr{d < Q} = 15/(5 + 15) = 0.75 so Q = 10,000 + 2,000 z 0.75 = 10,000 + (2,000)(0.67)  11,350 turtlenecks (z 0.75  0.67 is the 75 th percentile of the standard normal) Buy Q so that Pr{d < Q}  G/(L+G)

19. 19 Logistics for Services: Don’t Take ‘G’ and ‘L’ for granted! –How to reduce the cost of a stock-out: –How to reduce the cost of over-supply:

20. 20 Logistics for Services Another example: USAir Flights from Boston to Rochester (scheduled flight time of 78 minutes) histogram of flight duration (min.) July 1995 78 minutes (47th %-ile) 93 minutes (77th %-ile)

21. 21 Example from Air Transportation USAir Flight 380 –benefits of adding minutes to schedule –costs of adding minutes to schedule

22. 22 Apparel Supply Chain “Fashions” limit product shelf life Traditionally long production lead times  one production order once per season “Quick Response” – attempt to shorten production lead times  produce several times per season  reduced liquidation loss and lost sales

23. 23 Sport Obermeyer Problem: –need to order 10,000 parkas now, and 10,000 later when much more accurate demand forecasts will be available –need to order at least 600 parkas of a particular style at a time to achieve production economies of scale (both now and with later orders) –after second 10,000 parkas are ordered and the parkas are received, lost sales costs and liquidation losses are incurred

24. 24 Sport Obermeyer Observations: –Second round of orders should be used to “fine-tune” the total number ordered for each style –However, the second order for each style should be at least 600 parkas –For the first round of orders, we want to maintain a high probability that at least 600 more parkas are required in the second round, so that we are not caught in a situation where we would like to buy 300 or so parkas in the second round

25. 25 Insights Performance of the supply chain affected by: –inventory –capacity –material/information flow Change one, others may change too Trade-offs can be particularly acute in service supply chains. Wisely designed information and material logistics dramatically reduce costs and improve service.