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Specialty Toys: Case Study

Ngo Thanh Ha
Khuong Thi Thuy Tien
Tran Bich Phuong
Dang Khanh Linh
Dam Thi Tuyet
National Economics University
IS310 - Quantitative Analysis

Specialty Toys: Case Study

Executive Summary
Specialty Toys, Inc. is a manufacturer of new and innovative childrens toys which includes
the Weather Teddy. The Weather Teddy has a built-in barometer that provides one of five
standard responses about the weather when a child presses the teddy bears hand. The
company recently reached out to our team to prepare a managerial report addressing, but not
limited to, the following issues: normal probability distribution in relation to demand
approximation, the probability of stock-outs for certain quantities and the projected profits
associated with certain order quantities. The purpose of this managerial report is to address
the concerns of the management team at Specialty Toys, Inc. and also to provide a
recommended order quantity for the Weather Teddy, the probability of stock-outs related to
specific order quantities, and the potential profits associated with certain order quantities.

Specialty Toys Business Cycle


The company sells a variety of toys throughout the year. However, Specialty Toys plans to
release the Weather Teddy in October, before the holiday season is officially underway.
Management has determined that this is the best time to release a holiday gift because many
families have already begun shopping for holiday gifts at this time. In order to have the
Weather Teddy on the shelf by October, the company must place a one-time order with its
manufacturer in either June or July. Due to the large gap between when orders are placed and
actual products are produced, the most important question the company faces is determining
the correct number of units to purchase in order to meet customer demand. The company
must balance this desire to meet customer demand with the potential loses that could result
from having excess inventory left over from the holiday season that must be sold at a reduced
cost.

Specialty Toys: Case Study

There is considerable disagreement between the management team over what the correct
order quantity should be. Estimates have ranged from 15,000 to 28,000. This variation clearly
shows a large degree of disagreement amongst the management team over how successful
they believe the Weather Teddy will be. Through our discussions with management, we have
learned that each Weather Teddy will be sold for $24. Each toy will cost $16 for the company
to manufacture and sell. Therefore, the net profit for each Weather Teddy sold is $8.
However, any unsold Weather Teddys after the holiday season will be sold for a reduced
price of $5. Based on this discounted price, Specialty Toys will end up losing $11 on every
toy left over from the holiday season. In addition, Specialtys senior sales forecaster predicted
an expected demand of 20,000 units with a .90 probability that demand would be between
10,000 and 30,000 units. We used these management estimates to perform our analysis and
probability calculations.

Normal Probability Distribution


This managerial report is based on the Senior Sales Forecasters prediction that expected
demand for the Weather Teddy will be 20,000 units and that there is a 90% probability that
unit demand will be between 10,000 and 30,000 units.
Below is a distribution graph showing the details of the forecasters prediction. The mean of
the distribution is the expected 20,000 units and the standard deviation is 6079 units. Z
scores for the 90% probability that units sold will be between 10,000 and 30,000 units are 1.645 and +1.645, respectively.

.05

10,000
0

.90

20,000
3

.05
5
30,000
0

Specialty Toys: Case Study

At x = 30,000,

= 1.645

Normal distribution 20,000

Likelihood of Stock-Outs for Specific Order Quantities


As noted in the Specialty Toys Business Model section, the company must balance the
additional profits associated with each toy sold ($8) against the losses that will be incurred for
any toys leftover after the holiday season ($11). Below, we provide the probability that
Specialty Toys will run out of the Weather Teddy based on estimated quantities provided to
us by management.
@ 15,000

P(stockout) = 0.7939
Analysis: There is an approximately 79.39% chance that Specialty Toys will run out of the
Weather Teddy if the company orders 15,000 units.
@ 18,000

P(stockout) = 0.6293

Specialty Toys: Case Study

Analysis: There is an approximately 62.93% chance that Specialty Toys will run out of the
Weather Teddy if the company orders 18,000 units.
@ 24,000

P(stockout) = 0.2546
Analysis: There is an approximately 25.46% chance that Specialty Toys will run out of the
Weather Teddy if the company orders 24,000 units.
@ 28,000

P(stockout) = 0.0934
Analysis: There is an approximately 9.34% chance that Specialty Toys will run out of the
Weather Teddy if the company orders 28,000 units.

Profit Potential
Based on the case, where price of Weather Teddy p = $24, per unit cost c = $16, and
inventory will be sold at i = $5, profit can be calculated as followed:

If

If

Specialty Toys: Case Study

Order Quantity: 15,000

Unit
Sales
10,000
20,000
30,000

Total
Cost
240,000
240,000
240,000

Sales
at $24
at $5
240,000
360,000
360,000

25,000
0
0

Profit
25,000
120,000
120,000

Order Quantity: 18,000

Unit
Sales
10,000
20,000
30,000

Total
Cost
288,000
288,000
288,000

Sales
at $24
at $5
240,000
432,000
432,000

40,000
0
0

Profit
-8,000
144,000
144,000

Order Quantity: 24,000

Unit
Sales
10,000
20,000
30,000
Order Quantity: 28,000

Unit
Sales
10,000
20,000
30,000

Total
Cost
384,000
384,000
384,000

Total
Cost
448,000
448,000
448,000

Sales
at $24
at $5
240,000
480,000
576,000

70,000
20,000
0

Sales
at $24
at $5
240,000
480,000
672,000

90,000
40,000
0

Profit
-74,000
116,000
192,000

Profit
-118,000
72,000
224,000

Specialty Toys: Case Study

Accounting and Economic Profit Potential


One of Specialtys managers felt the profit potential was so great that the order quantity
should have a 70% chance of meeting demand and only a 30% chance of any stock-outs.
What quantity should be ordered under this policy, and what is the projected profit under the
three sales scenarios?
In order to calculate the quantity needed to ensure a 70% chance of meeting demand, we first
determined the Z score associated with a 70% probability. Using Microsoft Excel, we
calculated the Z score to be approximately .5244, rounding to four decimals. We can now
calculate the quantity associated with a 70% probability by inputting in our known values to
the following formula:

30%
70%

20,000 Q
z = 0.52

P (X < K) = 0.7
P (Z < (K 20,000) / 6079) = 0.7
(K 20,000) / 6079 = 0.5244
K = 20000 + 6079 * 0.5244 = 20000 + 2675 = 23,188 units to be ordered
In order to assure a 70% chance of meeting customer demand, we recommend that Specialty
Toys place a one-time order for 23,188 toys. The projected profits under the 3 scenarios are
computed below.

Specialty Toys: Case Study


Order Quantity: 23,188

Unit
Sales
10,000
20,000
30,000

Total
Cost
371,008
371,008
371,008

Sales
at $24
at $5
240,000
480,000
556,512

65,940
15,940
0

Profit
-65,068
124,932
185,504

Recommendations
There were several different factors that we took into account when making our
recommendation and deciding on a suitable order quantity. Factors to consider included the
probability of a stock out, potential profits from several different possible quantities
demanded, loss of profits in the event a stock out does take place, and finally added revenues
associated with the discount sale of excess goods on hand.
After analyzing the results of our calculations based on managements expectations, we find
the probability of demand being greater than or equal to 15,000 or 18,000 units is too large
for these quantities to be sufficient. Ordering a quantity of goods at far below level s of
expected demand create a high probability (80% and 63%) that Specialty Toys will sell out of
Weather Teddy stock and lose sales revenue. The probability of stock outages occurring
drastically decrease to 25 % and 9% in forecasts of higher quantities demanded of 24,000 and
28,000 units, respectively.
In addition, a single-period inventory model recommends an order quantity that maximizes
expected profit based on the following formula:

P(Demand Q* )

cu
cu co

Specialty Toys: Case Study

where P(Demand Q* ) is the probability that demand is less than or equal to the
recommended order quantity, Q * . cu is the cost of underestimating demand (having lost
sales because of a stockout) and co is the cost per unit of overestimating demand (having
unsold inventory). Specialty will sell Weather Teddy for $24 per unit. The cost is $16 per
unit. So, cu = $24 - $16 = $8. If inventory remains after the holiday season, Specialty will sell
all surplus inventory for $5 a unit. So, co = $16 - $5 = $11.

P(Demand Q* )

8
0.4211
8 11

0.4211

0.5789
Q*
z = -0.20

The profit projections for this order quantity are computed below:
Order Quantity: 18,784

Unit
Sales
10,000
20,000
30,000

Total
Cost
300,544
300,544
300,544

Sales
at $24
at $5
240,000
450,816
450,816

43,920
0
0

Profit
-16,624
150,272
150,272

Specialty Toys: Case Study

Based on the information in the case, we recommend a quantity with a large probability of
meeting customer demand. Specialty Toys should order the quantity that maximizes expected
profit of Weather Teddy. From the calculation above, we can see that if the company orders
18,784 units, the expected profit will be largest out of the four quantities, which is $150,272.
In order to have a better understanding of the specific quantity of units needed, more
information is necessary including industry sales trends of recent products and sales history of
similar products. Given the risks associated with over purchasing, Specialty Toys
management would also need to provide the interval of probability in which they expect to
meet consumer demand.
Other options that we alternatively recommend would be to negotiate higher rates with
contract manufacturers to produce additional rush orders in October if demand is high when
the toys are released. Additionally, Specialty Toys could sign contracts with discount retailers
prior to October specifying a fixed unit price (above the reduced price the toys would be sold
at) for all excess toys to avoid excess loss.

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