Soureing at Crome In April 2016, the Procurement Manager at Crome, Ms. Claire Chung, was reflecting on an eventful ‘year just gone by. Crome was a mobile device manufacturer and their flagship model is the MC20 series which was quite successful for many years. Crome would sell the MC20 model to retailers. ‘These retailers would place orders with Crome two months before the start of the selling period (each selling period is of twelve-month duration). These products had very short life cycle typically no more than 12 months. Demand tends to be highly uncertain and thus difficult to predict. Forecasting inaccuracies therefore made sourcing of raw material difficult. One of the critical components for MC20 is the LCD display. The sourcing for this component had a Jong lead time. The LCD display, supplied by Nanya Systems, would have to be ordered atleast 8 months before the selling period. The final product assembly time (done at Crome’ highly automated assembly line) was short, though. A batch of 250,000 can be produced in a day. In the past few years, Crome had a long-term annual contract with Nanya. In this contract, Crome ‘would specify the annual quantity, unit price and delivery date. The problem with Crome was th «demand realization was low, then they would be stuck with large volume of component inventory. if ‘Most of the component inventory can be used in Crome’s lower-end product versions, however, the LCD display was not used in other products because of dimension and the fact that this was one of the ‘major differentiating components in terms of resolution. Therefore, LCD display inventory were ‘written off if they were not utilized in that specific season when they were ordered. Spot market exists for select type of components (such as LCD display). When there was a shortfall of inventory of LCD display, Crome could access the spot market to source additional inventory at a short lead time (generally in a few days’ time before the season starts), Therefore, spot market was a good way to source, especially if the requirement was low. However, the unit spot price would not be known in advance. For a long-term contract, Crome was planning to negotiate a unit price of $17 per LCD display for 2017, Crome could salvage excess modules at $5.30 per unit. To build the next version of the MC20 for 2017, the cost of all other components was $102.5 per unit. The selling price to retailers would be $8150 per unit, Long term contacts and spot purchase are two extreme forms of contracts. Another type of contract which was becoming popular in the electronics industry was the options contract, Buyer pre-pays a relatively small fraction of the unit component price up-front (called options price or reservation fee) to reserve a specified quantity (called option quantity). The supplier commits to produce up to this specified level. Once the demand information is realized, the buyer can purchase any amount of quantity up to the options level by paying a unit additional price (or exercise price). The exerci ‘was agreed to at the time the contract was signed. Total price (options plus reservation price) is typically higher than the unit price in a long-term contract. price ‘Chung felt that an options contract might benefit both parties. She was also trying to analyse the cost implication of portfolio of contracts with Nanya. For the options contract, she was planning to negotiate with Nanya with the following parameters: the unit options price of $0.50 and a unit exercise price of $16.75. ‘Crome uses past sales data of MC20 series to predict the demand for the upcoming season.‘Question 1. Assume Crome ean souree LCD Display module from the spot market. Suppose Crome signs purchase contact with Nanya Systems for 2,150,000 units at $17 pr unit of dxpay. Assume thatthe other parts necessary fr the production of he MC20 are available, What is Crome’s expected profit? Inthe above scenario what isthe optimum purchase quantity? Question 2, Assume Crome cannot source LCD Display module from the spot market. What quantity should Crome contract through the options contract alone as envisaged by Chung? ‘The spot demand for the previous year and the past sales data for earlier versions of MC20 series are available in the accompanying Excel spreadsheet (see Moodle). ‘Quarterly demand for version of the MC cellphone Version 1 27,23,463 2 24,64,345 5 22,23,094 4 27,38,725 3 31,99,565 6 32,12,175 iu 23,56,641 8 16,80,760 9 9,94,350 10 | 8,72,841 u 21,46,563 12 26,47,838 3 i 15,11,062 4 - | 18,95,864 i 15 24,18,814 16 10,11,569 17 11,26,667 18 25,51,808 9 32,46,210 ‘Mean 21,59,071 Standard Deviation 772323Historical unit price of the LCD Display module in the spot market Week| 1538 Week 2 13.84 Week3 | 18.17 Week 4 | 21.02 Week S| 26.43 Week 6 | 13.09 Week7 | 18.00 Week8 [21.75 Week9 | 27.03 Week 10 | 15.05 Week 11 [26.89 Week 12 | 15.89 Week 13 | 14.06 Week 14 | 2438 Week 1S___| 17.27 [Week 16 | 20.62 Week 17 | 12.61 Week 18 | 18.89 Week 19 | 12.95 Week 20 [20.84 Week 21 | 15.39 Week 2222.38 | Week 23 | 2643, Week 24 | 18.46 Week25 | 16.20 Week 26 | 25.08 Week 27 | 26.72 Week 28 | 23.32 Week 29 | 17.31 Week 30 | 18.67 Week 31 | 14.55 Week 32 | 13.42 Week 33 [1787 Week 34 | 23.31 Week 35 | 21.70 Week 36 | 19.49 Week 37__[ 25.51 Week 38 | 19.27 Week 39 | 1433 Week 40 | 13.76 Week 41__| 17.84Week 42 [1643 | 21.80 [1629] Week 45 | 25.24 Week 46 | 24.18 Week 47 | 19.98 Week 48 | 19.51 Week 49 [18.22 | Week 50 | 17.36 Week 51 | 26.40 Week $2 | 25.52 Mean 19.54 Std Dev | 4.40