EWMBA 204: OPERATIONS - TUESDAY SECTION #4 - 8/30/2022

AGENDA

• Announcements
• Lecture Takeaways: EOQ, NEWSVENDOR, BEER GAME + BULLWHIP
• Practice Problems: EOQ & NEWSVENDOR
• Mid-Term Review: Selected Problems
• Q&A
ANNOUNCEMENTS

Great job on the midterms! Tonight’s discussion section will be the only time we review some
of the problems as a group. For additional help or questions, reach out to you GSI

There will be no class on 09/03 and no discussion section 09/06!

Due for Class #5 on 09/10:

● Complete Concept Check #2 → this is due before next class. You can complete it individually or
work in groups of two. Please make sure your group is registered under the ‘People’ tab
● Read the Zara Case
● Read Littlefield Technologies 2022
● Form & Register your Littlefield Simulation Team → See more details in the Syllabus.
A few keys things to note:
○ Each team will have four or five students from the same cohort
○ Students form their own groups, if you have difficulty forming a group, please contact your GSI
○ Please record your password and team name so that you can remember and use it several
weeks from now
LECTURE TAKEAWAYS - ECONOMIC ORDER QUANTITY (EOQ)

What to use it for?

Calculate the optimal order or batch size given two trade-offs between:
● Ordering or “Setup” Costs → The fixed cost of placing orders. These push in the
direction of large, infrequent orders
● Inventory or “Holding” Costs → The variable costs of holding inventory. This pushes
in the direction of small, frequent orders

Key Assumptions:
● Repeat/ongoing orders
● Demand is constant overtime
● An order or batch incurs a fixed,
unchanging “setup” cost
● Inventory has a variable cost
(i.e. total holding cost increases *

linearly with the number of units)

LECTURE TAKEAWAYS - EOQ EQUATIONS

Note: Annual Holding Cost sometimes has to be calculated from an annual holding rate (such as “10% of the unit cost”)
LECTURE TAKEAWAYS - EOQ EQUATIONS

Concept Abbrv Relationship

Demand (units / time) D Demand for your product
Setup (fixed) cost incurred per order ($) S Fixed cost per order/batch
Holding Cost ($ / unit / time) h Often calculated as a % of unit purchase cost
Unit Purchase Cost ($ / unit) c
Order Quantity Q
Economic Order Quantity (EOQ) EOQ or Q (2 * S * D / h) ^ 0.5
Average Inventory (units) Q/2
Number of orders per time (orders / time) D/Q

Setup Cost ($ / time) S * D / Q → should equal Inventory Cost

Inventory Cost ($ / time) h * Q / 2 → should equal Setup Cost

Purchase Cost ($ / time) c*D
Inventory Cost + Setup Cost + Unit Cost =
Total Cost ($)
h*Q/2+S*D/Q+c*D

Note: Be sure to use consistent time units for formulas (i.e. Annual Demand w/ Annual Holding Cost)
LECTURE TAKEAWAYS - NEWSVENDOR MODEL

What to use it for?

● There is a single order or production opportunity with a trade-off between:
○ Too little → If demand exceeds the order quantity, sales are lost
○ Too much → If demand is less than the order quantity, there is left over
● Newsvendor model takes into account:
○ The economics of having too much vs. too little
○ The riskiness in the demand forecast

Key Assumptions:
● “One Shot” ordering/production decisions
● Demand is uncertain
● Demand can be modeled with a normal distribution

*
LECTURE TAKEAWAYS - NEWSVENDOR MODEL

How to use it? Identifying Gain vs. Loss can take

some practice. Reviewing practice
● Step 1: Calculate the critical fractile problems will help!
○ G = Gain if stock additional unit and sell it
○ L = Loss if stock additional unit and don’t sell it (should be a positive number)
● Step 2: Look up the critical fractile in Standard Normal Probability Table to find
the z-score
○ An example Standard Normal Probability Table is posted in bCouses
○ If the critical fractile falls between two values in the table, choose the larger
z-score (per the Round-up Rule)
● Step 3: Convert the z-score into an order quantity
○ Quantity = Mean of Demand + Z-Score * Std Dev of Demand

Concept Abbrv Relationship

Gain G Gain if stock additional unit and sell it
Loss L Loss if stock additional unit and don’t sell it *
Critical Fractile G / (G + L)

“Round-up Rule”: Whenever you are looking for a target value in a table, and the target value falls
between two entries, choose the entry that leads to the larger order quantity
LECTURE TAKEAWAYS - EXPERIENTIAL SUPPLY CHAIN EXERCISE

Key Learnings:
● Demand information can be distorted; upstream decision makers may not see the
true picture of demand
● Order variability increases as you move up the supply chain from consumers to
suppliers (Bullwhip Effect)
● Beer game demonstrates amplification of variability and consequences of
over-reacting to uncertainty
Bullwhip Effect
● Devising effective strategies to counter the Bullwhip Effect requires understanding of
underlying causes
● Common Causes: Reactive & over-reactive ordering, trade promotions, forward
buying, and shortage gaming
● Counter-Strategies: Vertical integration, contracting, information sharing, etc
PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
1. What is the optimal order size?
2. What is the average inventory at Best Buy?
3. How many orders does the store place per year?
4. What are the annual ordering and holding costs?
PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
1. What is the optimal order size?
PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
1. What is the optimal order size?
WHAT IS BEING ASKED FOR? WHAT EQUATION(S) TO USE?

Economic Order Quantity (EOQ) =

Optimal Order Quantity

WHAT INFORMATION IS GIVEN? CALCULATIONS & ANSWER:

Concept Abbrv Value Units EOQ = ( 2 x 4000 x 12,000 / 100) ^ 0.5

1000 units / month
Demand D EOQ = 980 units
12,000 units / year

Setup Cost S $4000 $ / order

Unit Cost $500 $ / unit

Annual Holding Rate 20% % of Unit Cost
Annual Holding Cost h $100 $ / unit / year

Note: h = Annual Holding Rate x Unit Cost for this problem

PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
2. What is the average inventory at Best Buy?
PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
2. What is the average inventory at Best Buy?
WHAT IS BEING ASKED FOR? WHAT EQUATION(S) TO USE?

Average Inventory

WHAT INFORMATION IS GIVEN? CALCULATIONS & ANSWER:

Concept Abbrv Value Units Avg. Inventory = 980 / 2

Order Size = EOQ Q 980 units
Avg. Inventory = 490 units
PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
3. How many orders does the store place per year?
PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
3. How many orders does the store place per year?
WHAT IS BEING ASKED FOR? WHAT EQUATION(S) TO USE?

Number of Orders per Year

WHAT INFORMATION IS GIVEN? CALCULATIONS & ANSWER:

Concept Abbrv Value Units Number of Orders = 12,000 / 980

Demand D 12,000 units / year
Number of Orders = 12.2 orders / year
Order Size = EOQ Q 980 units
PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
4. What are the annual ordering and holding costs?
PRACTICE PROBLEM - EOQ

Demand for the Sub-Zero mini wine refrigerator at Best Buy is 1000 units per month.
BestBuy’s retail price for the refrigerator is $950, and Best Buy pays a $25 commission to the
salesperson on the store floor that made the sale. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4,000 each time an order is placed. Each refrigerator
costs Best Buy $500 and Best Buy has an annual holding cost of 20% of these purchase costs.
4. What are the annual ordering and holding costs?
WHAT IS BEING ASKED FOR? WHAT EQUATION(S) TO USE?

- Annual Inventory (Holding) Costs

- Annual Setup (Ordering) Costs

WHAT INFORMATION IS GIVEN? CALCULATIONS & ANSWER:

Concept Abbrv Value Units Inventory Costs = 100 * 980 / 2

Demand D 12,000 units / year
Inventory Cost = $49,000 per year
Setup Cost S $4000 $ / order
Setup Costs = 4000 * 12,000 / 980
Unit Cost c $500 $ / unit Setup Cost = $49,000 per year
Annual Holding Rate 20% % of Unit Cost
Annual Holding Cost h $100 $ / unit / year Note: At an order size = EOQ, your inventory costs
Order Size = EOQ Q 980 units and setup costs should be equal
PRACTICE PROBLEM - NEWSVENDOR

You are a retailer of trendy seasonal hats (e.g., you sell a fashionable winter hat during the
winter season). Demand for this fashionable hat is normally distributed with mean 1000 and a
standard deviation of 300. Each hat costs you $10. You sell each cap for $15. Caps unsold at the
end of the winter selling season can be discounted and sold off at $6.
1. How many caps should you purchase?
PRACTICE PROBLEM - NEWSVENDOR

You are a retailer of trendy seasonal hats (e.g., you sell a fashionable winter hat during the
winter season). Demand for this fashionable hat is normally distributed with mean 1000 and a
standard deviation of 300. Each hat costs you $10. You sell each cap for $15. Caps unsold at the
end of the winter selling season can be discounted and sold off at $6.
1. How many caps should you purchase?
PRACTICE PROBLEM - NEWSVENDOR

You are a retailer of trendy seasonal hats (e.g., you sell a fashionable winter hat during the
winter season). Demand for this fashionable hat is normally distributed with mean 1000 and a
standard deviation of 300. Each hat costs you $10. You sell each cap for $15. Caps unsold at the
end of the winter selling season can be discounted and sold off at $6.
1. How many caps should you purchase?

WHAT IS BEING ASKED FOR? WHAT EQUATION(S) TO USE?

Optimal Quantity (Q)

WHAT INFORMATION IS GIVEN? CALCULATIONS & ANSWER:

Concept Value Units Gain (G) = Margin on Hat = $15 - $10 = $5

Mean Demand 1000 hats
Loss (L) = Loss of Hat = $10 - $6 = $4
Std. Dev. of Demand 300 hats
Critical Fractile = 5 / (5 + 4) = 0.5556
Cost of Hat $10 $ / hat
Full Hat price $15 $ / hat
Z-Score = 0.14 based on the Standard Normal
Discounted Hat Price $6 $ / hat
Probability Table (see next slide)

Quantity = 1000 + 0.14 * 300 = 1042

PRACTICE PROBLEM - NEWSVENDOR

Critical Fractile = 0.5556

Based on the Standard Normal

Probability Table, this corresponds to
a Z-Score between 0.13 and 0.14.

Based on the Round-up Rule, use

Z-Score = 0.14

Note: An example Standard Normal

Probability Table is posted in bCouses
MIDTERM REVIEW - SELECTED PROBLEMS

Prepared Content → to be reviewed during the session but slides will not be posted
● Question 3 - all parts
● Question 4 - part a

Additional Help Needed?

● Review the provided solutions (you can find them under the Take Away Midterm
Assignment in bCourses)
● Review the other practice problems & solutions in bCourses -- there are problems
for posted for Part I & Part II of the class
● Email your GSI with questions and if needed to set up additional review time

*
QUESTIONS?