Inventory Management

Goal: Match supply with demand; 3 reasons to hold inventory – transaction (economies of scale + competition purpose),
precautionary (demand and supply uncertainty), speculative (fluctuating value and demand increase); Inventory costs –
carrying (insurance and maintenance), underage (loss of profit), overage (leftover), fixed ordering (setup- freight and
insurance, handling charges, negotiations); Newsvendor – uncertain demand, pre-commitment of order quantity, perishable
product; marginal analysis: incremental profit (expected value of the next one – check if positive); Critical Fractile –
Cu/Cu+Co (Pr(demand)<n); Cu = price – cost; Co = cost – salvage value; optimal quantity that maximize profit is CF; does
not experience a shortage: demand < n; if demand is normally distributed : n* is different but F(n*) is same as CF;
Read the table of the z
values properly; if
underage < overage,
produce less than
mean; Service level
requirement is
probability of no
shortage; service level if specified means that you don’t have to manually calculate the CF; EOQ not affected by lead
time; Average inventory = Q/2 (tradeoff between inventory and order frequency); EOQ also not affected by purchase cost
– represented by DC; ROP = D*L (if certain demand); safety stock can be negative
If CF>0.5, z* is
positive and ROP
is also positive;
reduce ROP to
reduce leftover;
Quantity discount
= basically start
with the lowest
price and calculate EOQ then if not feasible just keep doing it; after
solving until feasible one, look at break points and calculate the TC (DC + DS/Q + QH/2); EPQ = Inventory = Q/2*(1-D/P);
EOQ < EPQ; in EOQ = D/P is 0; EPQ optimal quantity is below (q is optimal size of prod run; cycle time is q/d; length of
prod run is q/p
Revenue Management
Simplicity is better sometimes for forecasting models; Simple Moving
Average- just add up and divide demand; how to choose n or the
number of moving average (larger n is more stable for the long term
but for shorter n, it is more accurate; it really depends on your
goal); weighted moving average puts percentages on particular
elements – recent data is higher weighting; SMA – based on ave past
demand and have equal importance to each; WMA – recent data is more
significant than older data; exponential smoothing – if alpha is 0,
doesn’t update forecast; a =1 then ignore forecast in past period (so find between)

Low alpha = stability; high alpha = close tracking

(depends on purpose of forecast); small a wont be
fooled by outliers
Regression – relationship as a function between
multiple variables; linear regression – straight line
relationship; Y = a+bx; SSE is the formula to the
right (goal is to find a,b) that minimizes the errors
(below_
Least squares method – summation of (Yi – Yhati)^2

Forecast accuracy: Error = Actual – Forecast; MAD = summation (absolute value (actual-forecast)/n) *it measures the
magnitude of forecast errors; TS = (summation of actual-forecast)/MAD * measures bias

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 Qualitative forecasting methods – market research, historical analogy, panel
consensus, Delphi method; advantages: does not require extensive historical
data; disadvantage: subjective; use when historical data are scarce or not
available at all and use expert opinion to predict future events subjectively
Customer segmentation – time-based and different customer classes
(quality); marginal analysis and newsvendor also used for figuring out the
optimal production level and determining overbooking stuff (RM with
capacity controls); when nothing said about optimal level then we can solve
the z thing (x-u/sd)
WTP is max cost a customer will incur to obtain a unit product (determined by customer characteristics, product
characteristics, availability of substitutes); to get the revenue maximizing price for single product pricing, you have to do
the derivative stuff; if D(p)=a-bp, then p* = a/2b; if linear model not known then you do price experiments but can’t
realistically do this for a long time, more data = better approximation; Linear demand model: advantages (simplicity, easy
to communicate, can say something between price breaks, many cases it’s a good approximation), disadvantages (non-
linear demand curve); multiproduct pricing – you basically do the same thing also; sample below
Pricing strategies: markdown, penetration, bundle,
psychological: decoy

Supply Chain Management

Supply chain is the system of organizations, people, activities, info an resources involved in moving a product/service from
supplier to customer; Risk – operational (mismatch between supply and demand, reducing expected profit flows
including inventory stuff) and financial (finance, transactions, loans, etc.); Hedging- Operational (constructions in
supply chains to reduce operational risks that may increase expected profits and reduce variance) and Financial
(constructions with financial instruments to reduce variance of profits);
Double marginalization – margins charged twice, suboptimal supply chain
performance occurs because each firm makes decisions based on own
margin not the supply chain’s margin, more stuff in supply chain = more
marginalization; Basic idea – single firm in supply chain is more efficient
If two players (pic on the left), w is wholesale;
either way supply chain profit is lower in the second
scenario; Different contracts – wholesale, revenue
sharing, returns
Contract – list of rules to control/modify goods and
cash flows in supply chain; verifiable and observable
for it to be effective
Wholesale – fixed wholesale price w for every
unit delivered to retailer (retailer determines
how much to order)
Revenue sharing – fixed price w for every
unit delivered to retailer; each unit sold to end
consumer, the retailer pays supplier fixed
percentage of y; retailer decides how many
prodcuts to order; revenue sharing
contract allow the decentralized supply chain to achieve the same profit as the
centralized supply chain (adjust the y); picking w = 30 and y = 0.7, idea is CF of
retailer has to be equal to first best CF; whole sale price does not affect supply
chain total profit; impt: order optimal quantity as the first best-outcome
Returns contract- supplier charges fixed price w for every unit; for every
leftover, supplier pays retailer fixed refund to the retailer; basically it allows
for risks to be shared among supply chain
members, it achieves not just supply chain coordination but also win-win outcome
for both supplier and retailer
Contract design: total profit pie (maximize system wide-efficiency), how to split
pie (terms attractive to both firms); Strategic fit over PLC- start: responsiveness
and later: efficiency; Supply chain demand and variability – long run: average
inflow = average outflow; volatility of inflow can differ from volatility of out
Bullwhip effect: consumer sales are
predictable and steady, retailer starts varying
as batch sizes affect then farther up is more;
Demand and inventory var. incr. as move away from customers
Consequence: high holding+backlogging costs, have cap. far exceed ave demand, poor cust service (stockouts), uncertain
and costly prod, high transport costs; Causes: order synch, order batching, trade prom/forward buying,
reactive /overreactive, shortage gaming; Solutions: info sharing (EDI + RFID), smooth product flow (reduce min
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 batch size, more freq replenish), removing pathological incentives (no forward, order based on past), Vendor-mgmt
inventory

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