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# DSC3201 Supply Chain Management Homework 1 Vu Kim Ngan (U097925Y)

## Question 1 (Chapter 2, #6)

The (Q,R) policy, i.e. (s,S) policy in our discussion has the reorder point equals : LTAVG + z STD LT This reorder point has two components: average demand during lead time (LTAVG) and the safety stock (z STD LT) to ensure certain service level due to variability in demand during lead time. Because the demand during lead time is expected to be LTAVG, the expected inventory level right before the new order comes in (or in other words, at the end of lead time) is determined by subtracting the expected demand during lead time from the re-order point: (LTAVG + z STD LT) (LTAVG) = z STD LT that is, the safety stock. The order quantity is Q (assumed to be determined by balancing fixed and variable costs) is placed to raise inventory position to S. When new order of Q comes in, the expected level of inventory is simply the sum of new order and whats left after satisfying demand during lead time, the safety stock: Q + z STD LT

## Question 2 (Chapter 2, #7)

Under periodic review policy, every review period, the warehouse would order enough to raise inventory position to the base-stock level: (L+r)AVG + z STD (L+r) The base-stock level consists of two components: the expected demand during a period of (L+r) days (until the next order arrives) of (L+r)AVG and the safety stock to ensure service level due to fluctuations in demand z STD (L+r). The time from when the order is placed (i.e. when inventory is reviewed) until received is the lead time L. During this period of L, we still experience demand during lead time, expected to be LxAVG. When new order comes in, the expected inventory level is determined by subtracting the expected demand during lead time from the base-stock level: (L+r)AVG + z STD (L+r) (LxAVG) = r x AVG + z STD (L+r) The time from when an order just arrives until the next order is received equals the review period r. Therefore, the expected inventory level before an order arrives is determined by subtracting the

DSC3201 Supply Chain Management Homework 1 Vu Kim Ngan (U097925Y) expected demand during the review interval from the inventory level at the time the last order was received: r x AVG + z STD (L+r) r x AVG = z STD (L+r) that is, the safety stock.

Question 3
Demand Scenario 8000 9000 10000 Probability 0.4 0.4 0.2

## p= \$300 w=\$80 v= \$20 c =\$30

a. From the retailers perspective: Underage cost = p w = \$220 Overage cost = w v = \$60 Retailers CR = Underage cost/(Underage cost+Overage cost) = 220/280 = 0.7857 Retailers Order Quantity is 9000 units (rounding up). Demand Sold Unsold Retailer Profit for each Retailer Profit for each Scenario Probability quantity quantity demand scenario demand scenario*probability 8000 0.4 8000 1000 1,700,000 680,000 9000 0.4 9000 0 1,980,000 792,000 10000 0.2 9000 0 1,980,000 396,000 Retailers expected profit Manufacturers Profit = 680,000 + 792,000 + 396,000 = \$1,868,000

## = (Wholesale price Manufacturing Cost)*Retailer Order Quantity = (80-30)*9000 =\$450,000

DSC3201 Supply Chain Management Homework 1 Vu Kim Ngan (U097925Y) b. From the Supply Chains perspective: Underage cost = p c = \$270 Overage cost = c v = \$10 SC ratio = Underage cost/(Underage cost+Overage cost) = 270/290 = 0.9643 Optimal Production Quantity is 10,000 units. Demand Sold Unsold SC Profit for each SC Profit for each demand Scenario Probability quantity quantity demand scenario scenario*probability 8000 0.4 8000 2000 2,140,000 856,000 9000 0.4 9000 1000 2,420,000 968,000 10000 0.2 10000 0 2,700,000 540,000 SC expected profit = 856,000 + 968,000 + 540,000 = \$2,364,000 c. It is possible to construct an option contract such that both manufacturer and retailer enjoy higher expected profit than the scenario described in part a. To begin, we first try to maximize system profit. The objective is for the retailer to order 10,000 units, that is, make retailer ratio closer (not necessarily equal) to SC ratio. To be specific, retailer ratio must be greater than 0.8. Suppose an option contract with reservation price r and execution price e. From the retailers perspective: Underage cost = p e r Overage cost = r CR = (p e r)/(p e r + r ) = (p e r)/(p e) We need CR > 0.8, i.e. r <60 - 0.2*e Any combination of r and e that satisfies the above condition ensure maximizing SC profit. By trial and error, we substitute different possible combinations of r and e to calculate expected profit of retailer and manufacturer respectively. One possible contract that yields higher expected profit for both parties is described below: Option order quantity Reservation Price Execution Price 10,000 units \$10 \$75

## DSC3201 Supply Chain Management Homework 1 Vu Kim Ngan (U097925Y)

Retailers profit = Executed Quantity*(p-r-e) Unexecuted Quantity*r Manufacturers profit = Option quantity*(r-c) +Executed Quantity*e + Unexecuted Quantity*v Demand Executed Unexecuted Retailer Profit for Manu. Profit for each Scenario Probability quantity quantity each demand scenario demand scenario 8000 0.4 8000 2000 1,700,000 440,000 9000 0.4 9000 1000 1,925,000 495,000 10000 0.2 10000 0 2,150,000 550,000

SC ratio Retailer Ratio Retailer Expected Profit Manu. Expected Profit Supply Chain Profit

## 0.9643 0.9556 1,880,000 484,000 2,364,000

Compare with part a, both retailer and manufacturer are better off with higher expected profit. The global optimization is reached using such option contracts as described above.