PRODUCTION AND OPERATIONS MANAGEMENT

Vol. 6, No. 3, Fall 1997

Primed in U.S.A.

CONFIGURING A SUPPLY CHAIN TO REDUCE THE

COST OF DEMAND UNCERTAINTY*

MARSHALL FISHER,JANICE HAMMOND, WALTER OBERMEYER, AND

ANANTH RAMAN
Department of Operations and Information Management, The Wharton School,
University of Pennsylvania, Philadelphia, Pennsylvania 19104-6366 USA
Graduate School of Business Administration,
Harvard University, Boston, Massachusetts 02163 USA
Sport Obermeyer Ltd., 115 AABC Aspen, Colorado 81611 USA
Graduate School of Business Administration, Harvard University
Boston, Massachusetts 02163 USA
Reducing lead time enables a company to react more quickly to demand information and, hence,
to better match supply with uncertain demand. But it is only one lever for improving response
capability. Managers are familiar with others (e.g., excess capacity, supplier choice, and so forth)
but lack techniques to quantify the impact of adjusting these levers. Here, we enumerate a number
of these levers and present a model whereby they might be combined into effective response
capability. The impact of adjusting these levers is illustrated by data obtained from a skiwear
manufacturer that did so. Some of the insights that resulted run counter to intuition.

Matching product supply with consumer demand is becoming increasingly difficult as

the rate of new product introduction continues to accelerate.. Unprecedented levels of
product variety have been attended by dramatic increases in inventory carrying costs,
markdowns and write-offs on excess inventory, diminished profit margin consequent to
stockouts, and other consequences of failing to match supply with demand. Department
store markdowns have risen more than threefold over the last two decades, from 8% of
sales in 1972 to nearly 26% in 1990.’
The problem is pervasive. Managers in industries as diverse as apparel, power tools,
computers, and footwear are struggling to cope with tremendous growth in new product
introductions. Figure 1 presents the example of the grocery industry; other examples can
be found in Fisher et al. ( 1994).
An inevitable consequence of the explosion in new product introductions, shortened
product life cycles, further impedes firms’ efforts to match supply with demand. In extreme
cases, a product’s supply lead time might exceed the duration of the selling period, pre-
cluding adjustments to supply after consumer demand for the product becomes known.
Even when production has not been completed before reading the market’s initial re-

* Received February 1996; revision received March 1997; accepted April 1997.
’ Financial and Operating Results of Department and Specialty Stores, National Retail Federation.
211
1059-1478/97/0603/211$1.25
Copyright B 1997, Production and Operations Management Society
212 M. FS%JER, J. HAMMOND, W. OBERMEYER AND A. RAMAN

18000
Total

18000

14000

Food Categories

12000

6000

4000

2000

0
1987 1988 1989 1990 1991

Year

Source: New Product News, Gorman Publishing, January 7, 1992

FIGURE 1. New Product Introductions, Grocery Industry.

sponse, limits on capacity during the selling season might constrain a firm from making
significant adjustments to its product supply.
IBM’s 2-year roller-coaster ride with four of its product lines is illustrative. Oversupply
of the PS/l model during the fourth quarter of 1993, according to industry analysts,
“strained relations with some retail chains, which were stuck with unsold machines.“*

2 Wall Street Journal, October 7, 1994.

 CONFIGURING A SUPPLY CHAIN 213

Meanwhile, throughout 1993 and 1994, IBM “struggle [ d] with shortages in the ThinkPad
line”” and “was burned by overly aggressive forecasts for the ValuePoint line, which
bloated its inventory to about $700 million in unsold PCs and forced it to resort to steep
discounts.“4 The news got worse. Reported the Wall Street Journal in October 1994:
“Just three weeks after announcing its new Aptiva home computer line, IBM Corp. is
sold out through year end and can’t fill all of its holiday orders. This shortage, which
IBM attributes to conservative forecasting, means the company could forgo tens of mil-
lions of dollars to revenue. . . . It shows that IBM has yet to solve its chronic problem
of miscalculating demand for its personal computers, which contributed to IBM’s drop in
U.S. market share to fourth place this year [1994] from a near tie for No. 1 in 1993.“5
Apple Computer fared no better. “When the PC market boomed,” observed Business
Week early in 1996, “Apple couldn’t keep up. Three-quarters of product shortages peaked
last September with what Apple said was a $1 billion backlog. Apple executives were
hard pressed to find supplies. . . . [CEO Spindler] ordered an all-out bid for market share.
The component shortages had eased and in November dealers were awash in Mats. . . .
But now Apple had the wrong mix of computers showing at retail: too many low-end
models and too few of the powerhouses that buyers were snapping up. . . . Apple was
left with $80 million worth of inventory write-offs, while IBM, Compaq Computer, and
HP had cleaned up.” 6
In their struggle to better match supply with demand, many companies are aggressively
trying to cut lead times.’ The logic of their actions is clear: if lead times can be shortened
such that production is largely in response to demand, forecast errors and associated over-
and underproduction might be avoided. Yet many of the companies that have succeeded
are now questioning the impact of lead time compression on their bottom lines, and even
the precise mechanism by which lead time reduction translates into increased profits.
Lead time reduction enables a company to commit resources such as production ca-
pacity or investment in inventory in response to more accurate information about demand.
But it is not the only way to improve response capability. Unexpected surges in demand
can be accommodated by excess capacity during peak production. A firm’s ability to
produce efficiently in small quantities, identify sources of market intelligence, and incor-
porate demand uncertainty into its production planning process also affects its response
capability.
Lead time reduction is a leavening agent. Our efforts here are directed at finding ways
by which it might be combined with other ingredients into appropriate “supply chain
recipes.” We advance one recipe for effective response capability below. Data collected
from a fashion apparel firm is employed to quantify the interactions that yield a supply
chain configuration appropriate to a given environment.

The Accurate Response Framework

We developed as an aid to manufacturers of short life-cycle products subject to uncer-
tain demand a general planning approach that we term “accurate response.“’ Our ap-
proach calls for firms to divide their production capacity into two distinct parts: speculative
production capacity employed before the observation of early indicators of market demand
and reacbve production capacity employed after early demand indicators are observed.

’ Wall Street Journal, May 2, 1994.

4 Wall Street Journal, October 7, 1994.
5 Wall Street Journul, October 7, 1994.
6 Business Week, February 5, 1996.
’ We define lead time as the sum of material acquisition, factory throughput, and transportation time.
’ The approach is described in detail in Fisher and Raman ( 1996), Fisher et al. ( 1994a), and Fisher et al.
(1994b).
214 M. FISHER, J. HAMMOND, W. OBERMEYER AND A. RAMAN

Accurate response is a risk-based production sequencing strategy whereby production of

low-risk products employs speculative production capacity and production of higher-risk
products is postponed until additional market information has been gathered. Precious
reactive production capacity is thus effectively reserved for products attended by the
greatest risk of mismatched supply and demand, and provision is made for companies to
update forecasts as market information becomes available. The accurate response model
can be employed in the context of limited production capacity and minimum lot size
requirements.
To investigate the effects of specific operational changes on profits associated with a
particular product, it is useful to locate the different phases of the production season on
a timeline such as that depicted in Figure 2. “FIT” represents the sum of factory through-
put time and transportation lead time.
We let to represent the beginning of the speculative production period. The first finished
units of speculative production are received subsequent to the expiration of factory
throughput and transportation lead times. Market intelligence is gathered concurrently
with speculative production. Market intelligence (I) gathered to date is summarized and
used to update demand forecasts at reaction point tl whereupon a second speculative
production period is committed. Reactive production begins at time f2, subsequent to
procurement of the necessary raw materials at time ( t2 - t, ) . The final unit of reactive
production, which begins at time 8 and requires ( t4 - t3) days to be produced and trans-
ported, is thus received at time t4.

Operational Levers that Facilitate the Matching of Supply and Demand

Managers grappling with the challenge of trying to match supply with rapidly changing
consumer demand know intuitively that certain operational changes will render their task
less difficult. Reducing lead times, for example, will enable them to reduce production
risk by delaying production commitments until more comprehensive market intelligence
can be gathered. Managers understand that the greater their reactive capacity, the greater
the proportion of production they can reserve until early demand indicators have reduced
demand uncertainty. They understand that high minimum production requirements con-
strain their ability to adjust supply to changing demand and that better, and earlier, market
intelligence would enhance their ability to produce the products customers want when
they want them. But few managers have the means to quantify the effects of specific
changes in these operational variables on their company’s bottom line.

Fact. Thruput
+ Trans. Time
Receive Speculative Production Receive Reactive Production

,,,*”
,,#”
,,o”
Reactive Production ,,,*““’
I
1 Fact.Thruput 1
‘3 +Trans.Time t,
(F1T)

Reaction
Point
FIGURE 2. Timeline for Production Decisions. (ar Represents the Sum of Factory Throughput Time and
Transportation Lead Time. Also, PIT = LT-MLT.)
 CONFIGURING A SUPPLY CHAIN 215

Below, we use the accurate response framework to model the impact of changes to a
number of operational variables on firm profitability. Specifically, we explore the rela-
tionship between profits and a host of variables, including excess capacity, percentage of
production produced reactively, shorter lead times, smaller minimum lot size require-
ments, and earlier, better market intelligence. The following notation is used to facilitate
discussion of these relationships (quantities are set forth in Figures 3 and 4).
K = daily speculative production capacity.
( 1 + R)K = daily reactive production capacity, where R is the factor by which daily
production capacity is augmented during the reactive period. Thus, R* K could be the
additional overtime capacity or subcontractor capacity available during each day of the
reactive production period.
0 = time of initial production commitment.
t,, = time speculative production begins (note that to = material acquisition time for
speculative production).
t, = time to acquisition of market intelligence (I).
t2 = time reactive production begins.
t2 - t, = to = MLT = material acquisition lead time for reactive production.
t3 = time reactive production ends.
Total speculative production capacity = K*( t2 - to).
Total reactive production capacity = ( 1 + R)* K*(t3 - t2).
t4 = time final production arrives at retail.
t4 - t3 = FZT = factory throughput time + transportation time.
Lead time = LT = FIT + MLT.
Increasing Reactive Production Capacity
To the extent that it reduces speculative production, additional reactive capacity can
clearly help firms minimize the stockout and markdown costs that dampen profits. To
determine whether to add additional reactive capacity and, if so, how much, a firm must
evaluate both the cost and value of each additional unit of such capacity.
The most economical increments to reactive capacity are temporary, maintained only
during peaks of production. Firms in labor-intensive industries might find temporary re-
active capacity in a workforce willing to work longer hours during production peaks.
Alternatively, subcontractors’ capacity can be exploited to augment reactive capacity,
although demand, and hence prices, for such capacity are likely to be highest during the
reactive production period.
Other approaches management might employ to increase reactive capacity are identified
in Figure 3, which incorporates production capacity into the timeline constructed in Figure
2. The resulting figure delineates several distinct phases that are critical to determining

Speculative Production Capacity Reactive Capaciw

Production
Commitment

FIGURE3. Factors that have an impact on Reactive Capacity.

216 M. FISHER, J. HAMMOND, W. OBERMEYER AND A. RAMAN

a Additional Reactive Capacity

Commitment commitment

b Additional Reactive Capacity

Additional Reactive Capacity

Production

FIGURE 4. a. Increase Total Capacity. b. Decrease Lead Times. c. Obtain Market Information Earlier. d.
Reducing Setup Times.

reactive capacity requirements, among them are the following: time to gather market
intelligence, time to acquire materials, the reactive production period, and factory through-
put and transportation time.
In Figure 4 we examine three approaches to increasing reactive capacity.
Increase total capacity. Expanding total (year-round) production capacity to increase
reactive capacity is practical only if the cost of capacity is sufficiently low, or can be
rented out, during the off-peak season.
The cost of adding capacity can be mitigated by shifting capacity costs from the fixed
to the variable category, for example, by developing a more flexible work force arrange-
ment that shifts (at least a portion of) labor costs from fixed to variable. The effect would
be similar to that of adding capacity only during peak production.
Reduce raw material acquisition lead time, factory throughput time, and/or transpor-
tation time. Reactive capacity is also gained when lead times are reduced. The shorter
the lead time, the greater the proportion of production that can be delayed until market
 CONFIGURING A SUPPLY CHAIN 217

Additional Reactive Capacity

Capacity

FIGURE 4. (continued).

information has been gathered and analyzed. That raw material acquisition lead time,
factory throughput time and transportation time directly affect the amount of available
reactive capacity is evident in Figure 4b.
Transportation lead times can be reduced by substituting air for terrestrial or water
transport. A firm that sources product internationally might, for example, switch to air
freight during the latter part of the reactive capacity period.
Lengthy material acquisition lead times force a greater proportion of season demand to
be produced on the basis of original, rather than updated, forecasts. Material acquisition
lead times can be reduced by collaborating with suppliers or inventorying long-lead-time
materials, and the risk of the latter minimized by designing greater commonality of ma-
terials into finished goods (forecasts for common materials being more accurate, according
to probability theory, than forecasts for finished goods).
Because an incremental unit of reactive capacity must be carried throughout the entire
production season (see Figure 4a), only a fraction of the increment ( t3 - t2)l( r3 - to) is
truly reactive. Lead time reduction, because it increases the duration of reactive capacity
(see Figure 4b), is a double-edged sword both edges of which cut costs. Lead time
reduction increases reactive capacity by lengthening the duration of the reactive produc-
tion period. Thus, it enhances the favorable impact of an additional increment of capacity
by increasing the fraction of this extra unit of capacity that can be used reactively.
In some situations, the steps adopted to reduce lead time could also lead to higher K.
For example, introducing flexible manufacturing systems that have the effect of reducing
inventory, enabling production in smaller batch sizes, and facilitating rapid switching from
one product to another can reduce factory throughput times while increasing K by reducing
the fraction of time devoted to setups. Figure 4d depicts the two ways in which additional
reactive capacity can be obtained from reduced setup times.
Secure market information earlier. Reactive capacity can also be increased by securing
market information earlier. Figure 4c illustrates how a greater fraction of season demand
could be scheduled reactively if market intelligence were available at time t I instead of
t, . Market intelligence can be obtained earlier by decreasing the time required to transmit
data (as by using EDI) or by investing in market research that reduces forecast uncertainty,
or inducing customers to order earlier.

Reducing Minimum Production Lot-Size Constraints

Setting minimum production lot sizes high limits a firm’s ability to tune supply to
demand by making it difficult to produce precisely what is required and to respond to
small fluctuations in demand. Consider, for example, a product for which demand is
known to be 600 units. If the minimum production quantity is set at 1200 units, the firm
218 M. FISHER, J. HAMMOND, W. OBERMEYER AND A. RAMAN

must either produce 1200 units (and risk incurring overstocks) or not produce the product
at all (and risk stockouts). Thus, in this case matching supply with demand is made more
difficult by minimum production quantities that force production commitments that differ
significantly from demand forecasts.
Large minimum production quantities, to the extent that they limit a firm’s ability to
react to demand signals, also reduce the value of reactive production capacity. The firm
referenced above, for example, would be unable to respond to a projected shortfall of 100
units except by overproducing 1,100 units. Smaller minimum production quantities that
let firms plan production in multiple smaller batches have an advantage that a fraction of
projected demand might be held back until additional market information becomes avail-
able. An example presented later illustrates how reducing minimum lot sizes decreases
stockout and markdown costs.

Improving Market Intelligence

Commitments of reactive production capacity are based on updated demand forecasts,
which, in turn, are based on the data gathered during the market intelligence period. To
be useful, this information must yield forecasts that correlate highly with eventual demand.
Market intelligence can be improved by collecting more demand data or by utilizing
available data more effectively. Observing more demand data before making the reactive
production commitment entails either ( 1) securing market information earlier (as ex-
plained above), or (2) delaying the reactive production commitment (and thereby reduc-
ing reactive production capacity). Opportunities abound, on the other hand, to use demand
data more effectively. Careful examination of demand data can reveal patterns that might
otherwise not be apparent. A Japanese bicycle manufacturer, for example, determined that
orders for custom-made bicycles were a good predictor of demand for mass-produced
bicycles. Many firms, moreover, lack systematic procedures for incorporating point-of-
sale data into demand forecasts and production plans, and in some firms point-of-sale data
are not used by production planners at all. Opportunities to improve data handling are
often readily apparent in such firms.

Quantifying the Impact of Operational Parameters at Sport Obermeyer

Quantifying the relationships between expected stockout and markdown costs and the
various managerial levers described above is critical to establishing optimal levels for
each of these levers. We attempted to do this for the Aspen, Colorado-based skiwear
manufacturer Sport Obermeyer using the Accurate Response framework discussed
earlier.g
Specialty ski retailers place -90% of their orders with Sport Obermeyer between mid-
February and mid-May. The remaining lo%, placed after September 1, are filled as in-
ventory becomes available. Inventory held by Sport Obermeyer that has not been sold by
December 31 is marked down for clearance.
Manufacturing occurs from January 1 to September 1, primarily in factories in Hong
Kong and China. More than a month is required to procure fabric and other materials
between commitment to and commencement of production (i.e., the cutting and sewing
of garments). Another month is required to complete production and 6 weeks to ship
products from East Asia to Sport Obermeyer’s Colorado warehouse.
Two production commitments are generally made each year. The first, which represents
-40% of projected season demand, is placed in late November. The second is made in
March, after some initial demand has been observed. Sport Obermeyer has shortened the
length of time it takes to acquire market intelligence through what it calls its “Early

9 Additional information about the company appears in Hammond and Raman ( 1994) and Fisher et al. ( 1994).
 CONFIGURING A SUPPLY CHAIN 219

Write” program, whereby selected retailers are invited to Aspen to preview the season’s
line. ( “Early Write” retailers place orders -4 weeks earlier than other retailers.) Reactive
(post “Early Write”) production capacity, available between March and September, lim-
its the size of Sport Obermeyer’s second production commitment.
Our analysis of the impact on cost of structural changes in Sport Obermeyer’s supply
chain are reported below. The mathematical formulation used at Sport Obermeyer is re-
produced in the Appendix.
Reactive Capacity
Figure 5 illustrates the relationship between expected stockout and markdown cost and
reactive capacity, which, as noted earlier (see Figure 4)) can be increased in a number of
ways. For each level of reactive capacity, we first calculated the optimal speculative
production for each product and used this production plan to compute the corresponding
expected stockout and markdown costs.” The optimal production commitment is lower
at higher reactive capacity. Notice from the model in the Appendix that if infinite reactive
capacity were available, the speculative production commitment would be zero; altema-
tively, if reactive capacity were zero, optimal speculative production commitment would
be equal to the newsvendor quantity for each item.
Notice from Figure 5 that costs decline sharply as reactive capacity is first added, but
the rate of decline slows with further expansion. The first 10,000 units of reactive capacity
reduces expected stockout and markdown costs by $198,000 (from $394,000 to
$196,000)) but the subsequent increase from 30,000 to 40,000 units yields a cost reduction
of only $23,000 (from $69,000 to $46,000). We would expect to draw for other companies
equivalent curves displaying diminishing marginal returns, although the precise shapes
might vary.
Because the first few units of reactive capacity are used to delay, in whole or in part,
production for which demand is highly uncertain at the start of the season, reductions in
stockout and markdown costs tend to be substantial. Subsequent additional reactive ca-
pacity, being used to delay production of styles for which demand is reasonably assured,
has relatively little impact on expected stockout and markdown costs.
Reactive capacity can be expanded by increasing total capacity (K), since reactive
capacity = K*( 1 + R)*( t3 - tz) (as demonstrated earlier). Optimal total capacity is
derived by trading off the cost of increasing total capacity against the beneficial impact
of the added capacity on stockout and markdown costs. Optimal total capacity will be
higher if the cost of capacity, determined by the cost of input factors such as labor and
machinery, is lower. In other words, access to inexpensive labor and machinery makes
excess capacity more affordable. Our analysis suggests that a firm selling labor-intensive
products such as fashion apparel in the United States might find more responsive suppliers
abroad than domestically since low wage rates enable suppliers in countries such as China
to afford excess capacity that can compensate for longer transportation times.
The foregoing insight contradicts conventional wisdom. Proponents of Quick Response
have argued that increasing demand uncertainty would cause firms such as Sport Ober-
meyer to turn to more responsive suppliers and that these would, by virtue of shorter
transportation times, be those located closest to the market. Our analysis suggests that
suppliers, located close to the market might be quick to deliver, but not be as responsive
as a lower-cost supplier located much further away.
Fraction of Season Observed before Making Revised Production Commitment
Market intelligence (I) increases as a firm waits to make its reactive production com-
mitment further into the season (t, in Figure 2). Increasing t, improves market intelligence

lo A discussion of our approach can be found in Fisher and Raman ( 1996).

 220 M. FISHER, J. HAMMOND, W. OBERMEYEIR AND A. RAMAN

400,000

350,000

&$ 300,000
5;
s
g 250,000
s
3
cd 200,000
2
::
c+i 150,000
x
ii
B
3 100,000

50,000

5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000

Reactive Capacity

FIGURE 5. Expected Stockout and Markdown Cost Versus Reactive Capacity.

to the extent that I comprises a greater fraction of the season’s orders. We found that just
as a little additional reactive capacity dramatically reduces stockout and markdown costs,
so a little additional order data significantly improves forecasts. That early season orders
correlated highly with and were a good predictor of total season orders is clearly illustrated
in Figure 6, in which the vertical axis denotes the correlation between season demand and
I, and the horizontal axis denotes the fraction of season demand captured in I.
Waiting for information, however, reduces the amount of reactive capacity available to
a firm. Determining how long to wait before making subsequent production commitments
involves trading off the value of additional capacity against that of additional information.
To assess how waiting for additional information might influence sales stockout and
markdown costs, we conducted a simulation that deviated from the reality at Sport Ob-
ermeyer in that it assumed orders are received uniformly throughout the selling season.
We began with the assumption that Sport Obermeyer made its reactive production com-
mitment early in the season after observing 0% of season orders, that is, when the quality
of information was poor and reactive capacity high. Figure 7 plots the sharp decline in
stockout and markdown costs that attends the company’s decision to delay its reactive
production commitment until some orders can be observed. This is consistent with Figure
6, which attaches a high marginal value to observing additional orders early in the season,
and with Figure 5, which suggests that the marginal value of the lost reactive capacity is
low in this context.
The situation is reversed on the right-hand side of Figure 7, which assumes Sport
Obermeyer to have considerable (low marginal value) information and little (high mar-
ginal value) reactive capacity. Were it in this region, Sport Obermeyer would be well
advised to make its reactive production commitment earlier in the season.
 CONFIGURING A SUPPLY CHAIN 221

0.9

0.8

0.7

z
gO6
2 .
z
2
c.Z 0.5
3
E
‘S
2 0.4

0.3

0.2

0.1

0
0 20 40 60 80 100
Percent of DemandObserved
FIGURE6. Correlation
of Season
Demand
withInitial Demand
Is High.

The lowest stockout and markdowns costs are observed in the middle, where the curve
is not particularly sensitive to the amount of time a firm waits to commit production. In
this region, capacity and information are more or less equally valued and the marginal
values of both very low. Were Sport Obermeyer to wait for 30% of orders before placing
its reactive production commitment, the marginal benefit of the additional information
would be low (the correlation in Figure 6 does not change significantly if we wait for
more information). Yet when reactive capacity is 70% of annual demand forecasts, the
marginal value of additional reactive capacity is also low.
Minimum Production Quantities
The cost of large minimum production quantities is captured in Figure 8. Consistent
with the other operational variables, initial reductions in minimum production quantities
are attended by lower stockout and markdown costs, subsequent reductions by decreasing
marginal returns. Smaller lot sizes, moreover, are associated with more frequent product
222 M. FISHER, J. HAMMOND, W. OBERMEYBR AND A. RAMAN

400000

350000

300000
lz
s
5
0 250000
s
z
-z
@ 200000
s
B
H
(I)
p 150000
Y
%
w
100000

50000

0
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Fraction of Annual Demand Observed Before Second Production Commitment
FIGURE 7. Stockout and Markdown Cost Versus Fraction of Orders Observed Before Second Production
Commitment.

changeovers with concomitant losses in productivity and increases in defect rates. Optimal
minimum production quantities can be established by trading off associated costs and
benefits.
Sport Obermeyer found that it could reduce minimum production quantities by switch-
ing from a Chinese supplier with a minimum production quantity of 1,200 units to a Hong
Kong supplier with a minimum production quantity of 600 units, but the switch would
have increased the per unit cost of production by 10-E% owing to the higher cost of
labor in Hong Kong. Sport Obermeyer used the analysis presented in Figure 8 to compare
the alternative production sources.
The value of reduced production minimums is a function of other operational variables.
At Sport Obermeyer, production minimums exert a greater impact on stockout and mark-
down costs when more information is gathered before making the second production
commitment (see Figure 9). Flexibility must thus be evaluated in light of the other op-
erational levers: reactive capacity and the timing and quality of market information.

Conclusion
To capitalize on the ideas presented in this paper, managers in industries that produce
uncertain demand, short life cycle products must begin by developing models of their
supply chains and identifying constraints (e.g., capacity at different stages, transportation
time, and so forth) that make it difficult to schedule production in reaction to demand
information. They must also understand the cost and effort required to relax these con-
 CONFIGURING A SUPPLY CHAIN 223

6.4
T
6.2

3
s
8
ci 5.4

5.2

5 I I I / I / I
0 200 400 600 800 1000 1200
Minimum Order Quantity
FIGURE8. Effect of Minimum Order Quantity on Cost.

straints. Subsequently, they will need to quantify the impact of relaxing these constraints
on their ability to match supply with demand, using the Accurate Response approach to
carefully incorporate attendant changes in the planning of speculative and reactive pro-
duction.
Quantifying the benefits of relaxing operational constraints can hold surprises, as we
have demonstrated in this paper. We were surprised, for example, to find that suppliers
located close to the market might not be the most responsive to consumer demand and to
discover the diminishing marginal impact of changes to most operational variables on
stockout and markdown costs.
Although supported by data from the fashion-apparel industry, the ideas presented here
apply to a wide range of industries. They have over the past couple of years been suc-
224 M. FJSHER, J. HAMMOND, W. OBERMEYER AND A. RAMAN

10 0% sales before tl
T

20% sales before tl

50% sales before tl

011 I
0 200 400 600 800 1000 1200
Production Minimum

FIGURE9. Production Minimums Have a Greater Impact on Cost as Mote Information Is Gathered Before
the Reactive Production Commitment.

cessfully presented in many executive education programs and influenced managerial

actions not only in other apparel companies, but also in companies that manufacture
personal computers, automobile accessories, chemicals, footwear, consumer durables,
pharmaceuticals, and sporting goods.

Jn this appendix, we model the production planning problem faced by Sport Obermeyer. The model was first
presented in Fisher and Raman ( 1996). We begin by introducing the following notation.
n = the munber of products,
xi0 = the number of units of product i produced before any demand information is obtained,
xi = the total number of units of product i produced during the season,
Die = demand for product i observed before the second production commitment,
Di = total units demanded for product i,
f( Die, Di) = joint density function for Die and D,,
~0 = the vector of xiO,
x = the vector of xi,
Oi = unit overproduction cost for product i,
Vi = unit underproduction cost for product i,
a+ = n-lax (a, 0).
Since daily production capacity during the reactive production period is denoted by K( 1 + R), capacity during
the entire reactive production period can be denoted by K( 1 + R) ( r3 - r2).
 CONFIGURING A SUPPLY CHAIN 225

Let s, E (1, 2, . . . n), j = 1,2, . m, be a family of sets that defines a partition of the product indices (1,
2,. . n ) . At Sport Obermeyer, Sj represented all colors of a particular style garment. Let x/, and XI denote
vectors of xi0 and xi, respectively, for i E S,, MT,, the minimum level for initial production of products in S,
(i.e., xi0 = 0, i E Sj or I&, xi0 2 M;) and &(x’,), the minimum level for reactive production of products in
Sj given initial production xi.
The decision process involves choosing ~0, then observing D0 and choosing x 2 G to minimize the total
underproduction and overproduction costs. The decision to choose x,, can then be represented as a stochastic
optimization program, thus
Z* = mitt Z(h),
such that (xi = 0) or

where
Z(xd = min E C c,(x,, 0,)
IES,
such that

xj = xi or xj 2 x!, and C (xi - x,,,) 2 M,(x/,)

iSS, I

.f, (Xi - x,0) s K( 1 + R)(i, - f*)

References
FISHER,M., J. H. HAMMOND, W. R. OBERMEYER,AND A. RAMAN (1994), “Malting Supply Meet Demand in
an Uncertain World,” Harvard Business Review, 72, 3, 83-93.
- ( 1994), “Accurate Response: The Key to Profiting from QR,” Bobbin Magazine, February, 48-62.
AND A. RAMAN ( 1996), “Reducing the Cost of Demand Uncertainty Through Accurate Response to
Early Sales,” Operations Research, 44,4,87-99.
HAMMOND, J. AND A. RAMAN ( 1994). Sport Obermeyer, Lid., Harvard Business School Case Study g-695-022,
Cambridge, MA.