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Krannert

School of Management

Midterm feedback

students found the pace too fast, and ~10% too slow

Today

3

Flanders of Springfield

Catalog Retailer

MGMT660

Introduction to

Operations Management

Important decisions:

What products?

Quantity to order?

Selling price?

Demand forecast

5

Forecast

Demand

MGMT660

2400 0.3

0.1

7

Expected contribution

MGMT660

Introduction to Operations

Management

600 (sale)

600 0.3

$27,000

2400 0.3 1200 x 100

1200 x 35 = $78,000

78000=$62,700

Expected profit

MGMT660

Introduction to

Operations Management

600 $39,000

$51,000

2400 $69,300

$52,800

9

Perfect information

MGMT660

10

Cost of mismatch

MGMT660

mismatch.

12

Discussion

MGMT660

13

Example: Mr. Smiths

(shortage)

MGMT660

Introduction to

Operations Management

15

Mr. Smiths Christmas

Tree Shop

MGMT660

Introduction to Operations

Management

16

Mr. Smiths Christmas

Tree Shop

17

Newsvendor Model

Place an order

Begin

End Shortage

MGMT660

Excess

Demand is realized

Objective:

18

Why Newsvendor?

Selling newspapers:

MGMT660

Important features

replenishment)

19

Where

can it be applicable?

Perishable items

Food

Seasonal goods

Fashion

MGMT660

Sports

Flu vaccine

Revenue management

Seats on a plane

Hotel rooms

Rental cars

Entertainment events

Service industry

Staffing

20

Discrete demand example:

calendar

production

MGMT660

Demand Probability

1,000 0.1

2,000 0.1

Salvage price: $1

3,000 0.2

Cost: $2

4,000 0.3

5,000

0.2

6,000 0.1

Mean 3,700

21

Produce mean

demand?

MGMT660

Left Short

1,700 0

0 300

6,000 0.1

3,700 0 2,300

Mean: 3,700 3,120 580 580

22

How much to produce?

MGMT660

23

Coincidence?

Demand

MGMT660

700 400

Q = E[Sales] + E[Leftover]

24

How much to produce?

MGMT660

1,400 100

Is it better? 25

Compare

profits

Sources of revenue:

Salvage: E

[Leftovers] * Salvage

MGMT660

Introduction

to Operations Management

Costs: Q * Cost

4,000 * 2 = $25,700

Expected: 3,600

1,400 100

26

Compare profits

Order Profit

3,000 21,300

MGMT660

4,000

25,700

5,000 27,400

6,000

27,300

7,000 26,300

Because having too many costs us less than having too few

27

Too many vs too

few

The consequence of ordering one unit too many than what you would have

Calendar: 2 1=1

MGMT660

Introduction to

Operations Management

Flanders: 35 15=20

Cu

The consequence of ordering one unit too few than what you

Calendar: 10 2 = 8

Flanders: 100

35 = 65

28

Newsvendor critical ratio

What is optimal Q?

F()

is the

CU

MGMT660

F (Q ) cumulative

CO CU

distribution

function (CDF)

This ratio is called the critical ratio or critical fractile.

29

What is the

optimal Q?

Heuristic arguments

P(Demand > Q) * CU

cumulative

distribution

MGMT660

Introduction to

Operations Management

P(Demand Q) * CO =F(Q) CO

30

Discrete demand: calendar

(D Q)

MGMT660

3,000 0.2

0.4

5,000

0.2 0.9

6,000 0.1 1

equal

31

Try Flanders on your own

value = 20;

65

Price $120

.764

CU CO CU 85

10035 = 65 12035=85

MGMT660

CO

3515 = 20 3515=20

CU

CO CU

0.764 .809

(Q)

1200 0.4

32

Continuous

demand distribution

distribution

MGMT660

Introduction to

Operations Management

Normal distribution tutorial

demand forecast.

MGMT660

z

36

Normal distribution tutorial

(D Q):

Distribution Function

MGMT660

Q z

CU

How to solve F (Q ) ?

CO CU

37

Newsvendor Example with

Normal

Distribution

MGMT660

Introduction to Operations

Management

Find z

Q* = mean + z

4000+ 1.29*1000 = 5290

38

Expected shortage, sale, and

profit

Expected Shortage = L

(z)

(z) = NORMDIST(z,0,1,FALSE)z*NORMSDIST(z)

MGMT660

Expected Profit =

Cost * Q

For calendar example:

We found z = 1.29

L(z) = 0.0465

39

Fill rate

Expected Sale

Fill rate

Mean Demand

MGMT660

Mean Demand

Expected Shortage

1

Mean Demand

40

Fill rate with Normal distribution

Calendar example:

We found z = 1.29

L(z) = 0.0465

MGMT660

Fill rate = 1

46.5/4000 = 98.83%

41

Service

Level

Calendar example

CU

F (Q )

MGMT660

9/10 = .9

CO CU

42

Purchase price: Cost: C

Revenue: R

Summary Slides

Salvage value: V

First

CU R C

CO CU (C V ) ( R C )

Discrete

demand

Pr{ Demand Q

} critical ratio

Calculate the expected profit: Price * Exp. Sales + Salvage * Exp. Leftovers

Cost * Q

Normal demand

Summary Slides

Mean demand ()

Standard deviation ()

zratio

Step 2: Convert z

Q* = + zratio

L(zratio)

Expected

profit: Price * Exp. Sales + Salvage * Exp. Leftovers

Cost * Q

Summary Slides

Expected Sale

Fill rate

Mean Demand

Mean Demand

Expected Shortage

Mean Demand

F (Q )

CO CU

45

Next time

More on newsvendor!

MGMT660

(posted on Blackboard)

46

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