Scanned with CamScannerEEEy Trade-Offs of Physical Centraliz n An online retailer is debating whether to serve the United States through four regional distribution centers or one national distribution center. Weekly demand in each region is normally distributed, with a mean of 1,000 and a standard deviation of 300. Demand experienced in each region is. independent, and supply lead time is four weeks. The online retailer has an annual holding cost of 20 percent and the cost of each product is $1,000. The retailer promises its customers next-day delivery. With four regional distribution centers, the retailer can provide next-day delivery using ground transportation at a cost of $10/unit. With a single national distribution center, the retailer will have to use a more expensive mode of transport that will cost $13/unit for next-day service. Building and operating four regional DCs costs $150,000 per year more than building and operating one national distribution center. What distribution network do you recommend? Assume a desired CSL of 0.95, Analysis: Observe that centralization decreases facility and inventory costs but increases transportation costs. We thus evaluate the change in each cost category on aggregation. We start with inventory costs. For each region, we have D = 1,000/week, op = 300, L = 4 weeks Given the desired CSL = 0.95, the required safety inventory across all four regional distribution centers is obtained using Equation 12.12 to be Total required safety inventory, ss = 4 X F;(CSL) x VL X op = 4 X NORMSINV(0.95) X Va X 300 = 3,948 Now consider the aggregate option. Because demand in all four areas is independent, p Using Equation 12.15, the standard deviation of aggregate weekly demand is Standard deviation of weekly demand at national distribution center, of = \/4 x 300 = 600 Fora CSL of 0.95, safety inventory required for the aggregate option (using Equation 12.16) is given as ss = F'(0.95) x VEX of Wecan now evaluate the effects of the chan *Reregation as follows: . ion = Ld xO Decrease in annual inventory holding cost on aggregation = (3.948 1,974) X $1,000 x 0. = $394,800 aggregation = $150,000 4.x 52. X 1,000 X (13 ~ 10) = $624,000 increase by $624,000 — $394,800 a Jer is better off with four regional = NORMSINV(095) X V4 X 600 = 1,974 iges in inventory, transportation, and facility costs on Decrease in annual facility costs on {ease in annual transportion costs on aggregation = Poeethatnthi costs forthe onlineretaileri $159, thiscase, theannual ‘The online rea 000 = $79,200 upon aggregation. Sa ee Scanned with CamScannerScanned with CamScanner516 Chapter 16 # Pricing and Revenue Management in a Supply Chain Separating segments based on how far in advance an order arrives. (yPicaly resus ig customers seeking lower prices arriving earlier and customers willing (0 Day higher pice, arriving later. For example, leisure travelers ae willing to purchase cheaper ticket fat in advan of a fight, Given that future demand of business travelers js uncertain, the airline must dig how much of the available capacity to allocate to leisure travelers and how much to save fp business travelers, As a result, a firm using revenue management across multiple segments mug solve the following two problems: 1. What price should it charge for each segment? 2, How should it allocate limited capacity among the segments? Pricing to Multiple Segments Let us start by considering the simple scenario in which the firm has identified criteria on which can separate the various customer segments. One such criterion may be an airline requiring 2 Saturday night stayover. Another might be a trucking company separating customers based on the advance notice with which they are willing to commit (0 a shipment. The firm now wishes ip identify the appropriate price for each segment. Consider a supplier (of product or some other supply chain function) that has identified k distinct customer segments that can be separated ‘Assume that the demand curve for segment i is given by (we assume linear demand curves to simplify the analysis) d= Ay Bip ‘The supplier has a cost ¢ of production per unit and must decide on the price p; to charge each segment; dis the resulting demand from segment /. The goal of the supplier is to price so as to maximize its profits, The pricing problem can be formulated as follows: ‘ Max 3; ~ eA, ~ Bip) Without a capacity constraint, the problem separates by segment, and for segment i the supplier attempts to maximize ~ (4; ~ Bip) ‘The optimal price for each segment iis given by An ie Pe OB 2 ble capacity is constrained by Q, the optimal prices are obtained by solving ‘ Max Si(o1 ~ (A, ~ Bip) (462) iat subject to (4, ~ Bip) = @ A,~ Bip, 20 for i=1,... Both formulations are simple enough to be solved in Excel. Example 16-1 illustrate the benef of differential prices to multiple segments (see worksheet Example 16-1 in workb0™ Chapter 16-examples), Scanned with CamScanneroe fjawilling to commit in advan = 5:000 ~ 20 p. Customers wit demand curve of d> = 5,000 ~ 40 p, the contract manufacturer charge each sepia turer were to charge a single price g in profits does differential pricing 14000 units, what should the contract manuf Analysis: ihout capacity constraints, the differenti ras 16.1. We ths obtain Hal prices to be charged each segment are given by 5,000, 10 B=2x20 2 ~ 195 +5=S130 and p, = 10 zy = 62.50 + 5 = $67.50 demand from the two segments is given by 4, = 5,000 — (20 X 130) = 2,400 and d= 5,000 — _ (40 x 67.5) = 2,300 The otal profit is Total profit = (130 X 2,400) + (67.5 x 2,300) ~ (10 x 4,700) = $420,250 {the contract manufacturer charges the same price p to both segments, itis atempting to maximize ___ ® ~ 10)(5,000 — 20 p) + (p — 10)(5,000 — 40 p) = (p — 10)(10,000 - 60 py ‘The optimal price in this case is given by 10,000 2x 60 The demand from the two segments is given by 4, = 5,000 — 20 x 88.33 = 3,233.40 and dy = |The total profit is ; Total profit = (88.33 — 10) x (3,233.40 + 1,466.80) = $368,167 {penal pricing thus raises the profits by more than $50,000 restive to offering a ined pes Pserve that differential pricing charges the more price sensitive segment less than And he less price sensitive segment more than te FASEB. 4000 unis Now, let us consider the case in which total production capa veh ean Tas We Optimal differential price results in demand that exceeds total prod ‘o the formulation in Equation 16.2 and solve 10 y = $88.33 ,000 — 40 x 88.33 = 1,466.80 The . Max(p, — 10)(5,000 — 20 p:) + @2 — 10)(5,000 — 40 p2) t Subj k ect to (5,000 ~ 20 p,) + (5.000 ee : (5,000 — 20/p1)» (5.000 ~ Scanned with CamScanner518 Chapter 16 ¢ Pricing and Revenue Management ina Supply Chain Cell Cell Formula | Copied to oS = 5000 - 20°85 C6 = 5000 - 40°86 Ds = (85-105 [D6 7 = sum(C5:C6) D7 = sum(D5:D6) Figure 16-3 Solver Spreadsheet for Example 16-1 ‘The results of the constrained optimization (using Solver in worksheet Example 16-1) are shown in Figure 16-3. The contract manufacturer charges the two ‘Segments $141.7 and $79.2 per Scanned with CamScannerABG caters to 2 different segments of customers, one (x) willing to order 15 days prigrto the need and prepared to pay Rs 500 per kg while the other (Y) is willing io, payRs 700 per kg, but cannot wait formore than5 days. The demand pattern forthe customer who gives4ess ead time is normaly distributed witha mean of 2 MT with a standard deviation of 5 MT. How much capacity should ABC allocate for Y? If X is ‘Brepared to pay only Rs 300 per kg, how will ABC's decision change? If ¥ insists that he hasto be supplied his full requirement g0% of the times, what should ABC insist 907(X's price at Rs 300) Scanned with CamScanner~ <1) YUPRH 0.9) ment is normally distributed, with a mean of Dy anda the quantity reserved for the higher-price segment as If demand for the higher-price segi sandard deviation of oy, we can obtain Ca = FQ ~ pulpy Dy on) = NORMINV — Pulp. Dip 04) (16.4) iced segment. An important point to observe is that the use of differential pricing increases the level of ‘set availability for the high-priced segment. Capacity is being saved for these customers who will arrive later because of their willingness to pay more for the asset. Thus, effective use of ‘venue management increases firm profits and improves service for the more valuable customer ‘gment while providing low prices to a limited number of customers in the price sensitive Segment. Example 16-2 illustrates how Profits can be increased by reserving capacity for the higher paying segment when demand is uncertain (see worksheet Example 16-2). EEE atocaing Capacity to Uncertain Demand from Multiple Segments ToFrom Trucking serves two segments of customers. One segment (A) is willing to pay $3.50 tb tie foot but wants to commit 0 a shipment with only 24 hours’ notice. The other segment 'S Willing to Pay only $2.00 per cubic foot and is willing to commit to a shipment with up to tistip cn, Notice. With two weeks to go, demand for segment A is forecast to be normally annbuted, with a mean of 3,000 cubic feet and a standard deviation of 1,000. How much of the nullable capacity should be yeserved for segment A? How should ToFrom change its decision if i ‘SMment A is willing to pay $5 per cubic foot? Scanned with CamScannerChapter 16 @ Pricing and Revenue Management in a Supply Chain Analy: In this case we have Revenue from egment A. py = $3.50 per cubic foot Revenue from segment B, pp = $2.00 per cubic foot Mean demand for segment A, Dy = 3.000 cubic feet Standard deviation of demand for segment A, 04 = 1,000 cubic feet Using Equation 16.4, the capacity to be reserved for segment A is given by Cy = NORMINV( = pplpy, Da, 24) = NORMINV(L ~ 2.00/3.50, 3,000, 1,000) = 2,820 cubic feet ‘Thus, ToFrom should reserve 2,820 cubic feet of truck capacity for segment A when custome from this segment are willing to pay $3.50 per cubic foot. If the amount these customers ae willing to pay increases from $3.50 to $5.00, the reserved capacity should be increased to Cy = NORMINV( — ppp, Das os) = NORMINV(1 — 2.00/5.00, 3,000, 1,000) 3,253 cubic feet Scanned with CamScanner4. Aztec Computers is preparing a strategic plan for the next 3 years which will decide about their growth. They want to follow a model that will adapt to new information. Sales data for the last 6 years have been collected that suggests that Aztec has been growing consistently year on year. What will be your forecast for the next 3 years? ( You can take a as 0.3 and B as 0.2) Sales data: 2012 - 12750 units: 2013 — 14200 units; 2014 - 16650 units; 2015 — 17800; 2016 — 18600 units; 2017 — 19100 units. What does the trend suggest? Scanned with CamScannerTREND-CORRECTED EXPONENTIAL ‘SMOOTHING (HOLT’S MODEL) The trend-corrected exponential smoothing (Holt’s model) method is appropriate when demand is assumed to have a level and a trend in the systematic component, but no seasonality. In this case, we have Systematic component of demand = level + trend We obtain an intial estimate of level and trend by running @ linear regression between demand, Dj, and time, Period t, of the form D,=a+b Scanned with CamScannerly Chain Demand Forecasting in # SupPh 214 Chapter? + i ‘ase, running. a linea 1 regression between demand and tne pigs In this ¢ se ye that demand as a rend But wo seasonality. The ype hy et .d and time is thus linear. ‘The constant b measures the ¢ re bet ‘mn timate gp lin Edi imate of the initial level Lp. The slope a measures ya”! stimate oF fee Period 1 = Oand is our e ia in demand per peri is our initial estimate of the trend 7), i veriod and is our initial ' in Period given estimates of level Ly and trend Ty the Forecast fry fs xpressed aS ‘ i Far = lit % and Fan = Ly + a, ‘Aer observing demand for Period f, we revise the estimates for level ang te fy fy Loa = @Dyas + (1 ~ aL; + 7) ly Oy, Tar = Br ~ Ld + - BT ; My i ing constant for the level and (0 < g < (0 < a < 1) is a smoothing constant Di coupe the tend. Observe that in each ofthe two updates, the revised einai corey ica weighted average ofthe observed value and the old estimate. We ils qe Holt’s mode! in Example 7-3 (see associated spreadsheet Examples !~4 Chapter 7, ‘An electronics manufacturer has seen demand for its latest smartphone increase overt pas months. Observed demand (in thousands) has been Dy = 8,415, Ds = 8,732, D,= say, Dy = 9808, Ds = 10,413, and Dg = 11,961. Forecast demand for Period 7 any trend-corrected exponential smoothing with a = 0.1, B = 0.2. Analysis ‘The first step is to obtain initial estimates of level and trend using linear regression. We fisia a linear regression (using the Excel tool Data|Data Analysis | Regression) between demu time periods. The estimate of initial level Lo is obtained as the intercept coefficient, and teal Tpis obtained as the X variable coefficient (or the slope) in the spreadsheet Exanples 4 Chapter 7 (there is some variation between the spreadsheet and the results shiowa here bese ‘of rounding). For the smartphone data, we obtain Ip = 7,367 and T) = 673 ‘The forecast for Period 1 (using Equation 7.14) is thus given by Fy = [In + Ty = 7,367 + 673 = 8,040 The observed demand for Period 1 is D, = 8,415, The error for Period 1 is tsi E, = Fi — D, = 8,040 ~ 8,415 = -375 With @ = 0.1, B = 0.2, th : or re Equations 7.15 and 7.16 given by ee Cae ts Fadi + (= aly + 7) = (0.1 x 8,415) + (0.9 x 8,040) = 8078 i Bila ~ La) + (1 ~ Bg = [02 x (8,078 — 7.3679] + 08 X 6) Observe that the initial estimat I a e te for demand in Period 1 is too low. As areSUt gt have increased the imate of evel, for Period | from 8,040 08078 nde sas n 673 to 681. Using Equation 7.14, we thus obtain the following forecast for P= Ly +7, = 8078 + 681 = 8,759 oil Scanned with CamScannera Chaptet 7 @ Demand Forecasting in a Supply Chai Continuing in this manner, we obtain L, = 8,755, T, = 680, Ly = 9,393, Ty = 672, Ly = 10,039, 7 = 666, Ls = 10,676, T; = 661, Lg = 11,399, T, = 673. This gives us a forecast for Period 7 of F, = Lg + Ts = 11,399 + 673 = 12,072 Scanned with CamScannerb) Crunchy, a cereal manufacturer, has dedicated a plant for one major retail chain. Sales at the retail chain average about 20,000 boxes a month and production at the plant keeps pace with this average demand. Each box of cereal costs Crunchy $3 and is sold to the retailer at a wholesale price of $5. Both Crunchy and the retailer use a holding cost of 20 percent. For each order placed, the retailer incurs an ordering cost of $200. Crunchy incurs the cost of transportation and loading that totals $1,000 per order shipped. |. Given that it is trying to minimize its ordering and holding costs, what lot size will the retailer ask for in each order? What are the annual ordering and holding costs for the retailer as a result of this policy? What are the 1 annual ordering and holding costs for Crunchy as a result of this policy? What is the total inventory cost across both parties as a result of this policy? li, _b) What lot size minimizes the’ inventory costs (ordering, delivery, and holding) across both Crunchy and the retailer? How much reduction in cost relative to (a) results from this policv? Scanned with CamScannerOptimal Lot Sizing for a Single Product (Economic Order Quantity) In this section we obtain the optimal lot size when a single product is purchased or produced to meet steady demand. Consider the purchasing manager at Best Buy who places a replenishment order for a new ot of Q Apple computers each time the store is running out of stock. Including Scanned with CamScanner308 Chapter 11 @ Managing Economies of Scale in a Supply Chain Cycle Inventory the cost of transportation, Best Buy incurs 2 fixed cost of $5 per order. The purchasing ust decide on the number of computers to order from Apple in alot. ‘Assume tat Apple does nt offer any discounts, and each Unit €0sts $C no mare large an order is. The holding cost is thus given by H = AC (using Equation 11.2). The mode, developed using the following basic assumptions: \ is units per unit time. x Demand ea) edit al demand must be supplied from stock, 3, Replenishment lead time is fixed (intially assumed to be zero) Manage, sizing decision to minimize the total cost forthe ‘The purchasing manager makes the lot-sizing iin | rahe must consider thee costs when deciding on the lot size: + Annual material cost + Annual ordering cost + Annual holding cost Because purchase price is independent of lot size, we have Annual material cost = CD i ‘The number of orders must suffice to meet the annual demand D. Given a lot size of Q, we thus have D Number of orders per year’ = a3) Because an order cost of Sis incurred for each order placed, we infer that Annual ordering cost = (2)s (4) Given a lot size of Q, we have an average inventory of Q/2. The annual holding costisthes the cost of holding Q/2 units in inventory for one year and is given as Annual holding cost = (2) = (2)c ‘The total annual cost, TC, is the sum of all three costs and is given as Total annual cost, 7C = ()s + (Shc +c nemrtt! ua Shows the variation in different costs as the lot size is changed. Observe ae ing cost increases with an increase in lot size. In contrast, the annual ordering eclines with an increase in ot size. The material cost is independent of lot size because We BS assumed the price to be fixed. The total annual cost thus first declines and then increases i increase in lot size. From the perspective of the m: i ini ofthe manager at Best Buy, the optimal lot size is one that (ell oso Best Buy. ts obtained by taking the fst dentate of th ttl ot WD is refered petal 100 (see Appendix L1A at the end of ths chapter. The optimal following equations on™ O74 Quantity (EOQ). I is denoted by Q" and is Be 5 Optimal lot size, @” = pe ee Fortis forula itis important o use the same time unit forthe boing cost ‘mand D. With each lot or batch of size Q", the cycle inventory in the system is i"? Scanned with CamScanner(Chapter 11 # Managing Economies of Scale ina Supply Chain Cycle Inventors 309 Cost! ‘Total Cost ~ Holding ‘Cost Ordering Cost Lot Size [Figure 11-2° effect of Lot Size on Costs at Best Buy The flow time spent by each unit in the system is given by Q°/(2D). As the optimal lot size increases, so does the cycle inventory and the flow time. The optimal ordering frequency is given lyn’, where pos. Pe g 2s InExample 11-1 (see spreadsheet Chapter! -examples!-6, worksheet Example 11-1), we issrate the EOQ formula and the procedure to make lot-sizing decisions. Een Economic Order Quantity Demand forthe Deskpro computer at Best Buy is 1,000 units per month. Best Buy incurs a fixed ‘kr placement, transportation, and receiving cost of $4,000 each time an order is placed. Each ‘wapter costs Best Buy $500 and the retailer has an annual holding cost of 20 percent. Evaluate ‘euunber of computers that the store manager should order in each replenishment lot. Aas, sae the store manager has the following inputs: Annual demand, D = 1,000 X 12 = 12,000 units Arle cost per lot, $ = $4,000 nit cost per computer, C = $500 tg, iit cost pr year asa fraction of unit cost, = 02 OQ formula (Equation 11.5) the optimal lot size is 4,000 a 16) Scanned with CamScanner11. Managing Economies of Seale in a Supply Chain Cycle Znventory Thapter For a lot size of Q” = 980, the store manager evaluates D _ 12,000 Number of orders per year = = = ~ogq = 12.24 5 7 Annual ordering and holding cost = 0-5 + (Sic = $97,980 Q 980 SF = Scrxoop ~ 2041 year = 049 mont Average flow time = Each computer thus spends 0.49 month, on average, at Best Buy before it is sold because it purchased in a batch of 980. . Scanned with CamScanner