Determining Optimal Level of

Product Availability
Supply Chain Management

Siddhesh akhuj 23157

Devendrasingh Chavhan 23158

Copyright ©2013 Pearson Education. 13-1

 Learning Objectives
• Importance of level of product availability
• Factors to consider when setting availability levels
• Newsvendor model
• Managerial “levers” for improving supply chain
profitability
• Value of postponement in a supply chain
• Setting optimal levels of product availability in
practice
• Double marginalisation; contracts

Copyright ©2013 Pearson Education. 13-2 2

 Product Availability: Tradeoffs
• High availability =>
– responsive to customers
– attract increased sales
– higher revenue
• High availability =>
– larger inventory
– higher costs
– risk of obsolescence

• Nordstrom, Marks & Spencer, Escada

• Bossini, supermarket, Fa Yuen Street

• E-commerce
– customer can find alternate source easily
– pressure on manufacturers to increase availability

Copyright ©2013 Pearson Education. 13-3 3

 Newsvendor Model
• single period model (one selling season)
(one-time order, e.g. for quantity
discount)
• demand uncertainty
• order placed (and delivered) before demand is known
• unmet demand is lost
• unsold inventory at the end of the period is discard (or
salvaged at lower value)

How much to order?

Copyright ©2013 Pearson Education. 13-4 4

 Factors affecting availability
• Demand uncertainty
• Overstocking cost C0
– = loss incurred when a unit unsold at end of selling season
• Understocking cost Cu
– = profit margin lost due to lost sale (because no inventory
on hand)
• Customer/Cycle service level CSL
– =level of product availability
– = Prob(Demand < stock level)

Copyright ©2013 Pearson Education. 13-5 5

 Determining Optimal Level of Product
Availability
• Single period
• Possible scenarios
– Seasonal items with a single order in a season
– One-time orders in the presence of quantity
discounts
– Continuously stocked items
– Demand during stockout is backlogged
– Demand during stockout is lost

Copyright ©2013 Pearson Education. 13-6

 Example: Selling parkas at LL Bean
Cost per parka = c = $45
Sale price per parka = p = $100
Inventory holding (until season end) and transportation cost
(to outlet store) per parka = $10
Discount price per parka (season end sales) = $50
Salvage value per parka = $50 -$10 = $40 = s

Cost of overstocking = Co = $45 + $10 - $50 = c - s = $ 5

Marginal profit from selling parka = cost of understocking = Cu
= $100 - $45 = p - c = $55

Copyright ©2013 Pearson Education. 13-7 7

 L.L. Bean Example – Demand Distribution
Table 13-1

Demand Di Cumulative Probability of Probability of Demand

(in hundreds) Probability pi Demand Being Di or Less (Pi) Being Greater than Di
4 0.01 0.01 0.99
5 0.02 0.03 0.97
6 0.04 0.07 0.93
7 0.08 0.15 0.85
8 0.09 0.24 0.76
9 0.11 0.35 0.65
10 0.16 0.51 0.49
11 0.20 0.71 0.29
12 0.11 0.82 0.18
13 0.10 0.92 0.08
14 0.04 0.96 0.04
15 0.02 0.98 0.02
16 0.01 0.99 0.01
17 0.01 1.00 0.00
Copyright ©2013 Pearson Education. 13-8
 LLBean: Expected Profit
Expected demand 17
 
Expected profit if order 10
j 4
j  p j  10

10
  pi [i ( p  c)  (10  i )(c  s )]  [1  P10 ](10)( p  c)
i 4
Expected profit if order k
k
  pi [i ( p  c)  (k  i )(c  s )]  [1  Pk ](k )( p  c)
i 4

Copyright ©2013 Pearson Education. 13-9 9

 LLBean: Expected profit

Demand Probability Sum(d(i)xp(i)) Cumulative Prob. Prob. demand greater Expected profit
d(i) p(i) P(i) = Pr( D < d(i) ) 1 - P(i) = Pr( D > d(i) ) if stock d(i)
4 0.01 0.04 0.01 0.99 220.00
5 0.02 0.14 0.03 0.97 274.40
6 0.04 0.38 0.07 0.93 327.60
7 0.08 0.94 0.15 0.85 378.40
8 0.09 1.66 0.24 0.76 424.40
9 0.11 2.65 0.35 0.65 465.00
10 0.16 4.25 0.51 0.49 499.00
11 0.20 6.45 0.71 0.29 523.40
12 0.11 7.77 0.82 0.18 535.80
13 0.10 9.07 0.92 0.08 541.60
14 0.04 9.63 0.96 0.04 541.40
15 0.02 9.93 0.98 0.02 538.80
16 0.01 10.09 0.99 0.01 535.00

Copyright ©2013 Pearson Education. 10

13-10
 Newsvendor : Marginal Analysis

Stock one unit if …

Stock 2 units (instead of 1 unit) if ...

Stock 1 Stock 2 Stock 3
D=0
D=1
D=2
D=3

Copyright ©2013 Pearson Education. 11

13-11
 Additional
contribution
keep order size at k
0
1 more unsold
Pk Co
order k+1
instead of k 1-P Cu
k 1 fewer lost sale

Order k+1 instead of k if

Pr(D>k) Cu Pr(D<k) (Co) > 0
or Pr(D< k ) (Co) + [1-Pr(D<k)] Cu > 0

Increase order from k to k+1 if

Prob(Demand < k) < Cu
Co + C u
Copyright ©2013 Pearson Education. 12
13-12
 LL Bean
Demand Probability Cumulative Prob.
Cu  p  c  100  45  55 d(i)
4
p(i)
0.01
P(i) = Pr( D < d(i) )
0.01

Co  c  s  45  40  5 5
6
0.02
0.04
0.03
0.07
7 0.08 0.15
Cu 8 0.09 0.24
critical ratio  9 0.11 0.35
C o  Cu 10 0.16 0.51
11 0.20 0.71
55 12 0.11 0.82
  0.917 13 0.10 0.92
5  55 14
15
0.04
0.02
0.96
0.98
so order 13 16 0.01 0.99

Copyright ©2013 Pearson Education. 13

13-13
 L.L. Bean Example

Additional Expected Marginal Expected Marginal Expected Marginal

Hundreds Benefit Cost Contribution
11th 5,500 x 0.49 = 2,695 500 x 0.51 = 255 2,695 – 255 = 2,440
12th 5,500 x 0.29 = 1,595 500 x 0.71 = 355 1,595 – 355 = 1,240
13th 5,500 x 0.18 = 990 500 x 0.82 = 410 990 – 410 = 580
14th 5,500 x 0.08 = 440 500 x 0.92 = 460 440 – 460 = –20
15th 5,500 x 0.04 = 220 500 x 0.96 = 480 220 – 480 = –260
16th 5,500 x 0.02 = 110 500 x 0.98 = 490 110 – 490 = –380
17th 5,500 x 0.01 = 55 500 x 0.99 = 495 55 – 495 = –440

Table 13-2

Copyright ©2013 Pearson Education. 13-14

 L.L. Bean Example
Figure 13-1

Copyright ©2013 Pearson Education. 13-15

 EXAMPLE A product is priced to sell at $100 per unit, and its cost is constant at $70 per unit. Each unsold unit has a salvage
value of $30. Demand is expected to range between 35 and 40 units for the period: 35 units definitely can be sold and no units
over 40 will be sold. The demand probabilities and the associated cumulative probability distribution (P) for this situation are
shown on next slide.
The marginal profit if a unit is sold is the selling price less the cost, or Cu = $100 − $70 = $30.
The marginal loss incurred if the unit is not sold is the cost of the unit less the salvage value, or Co = $70 − $30 = $40.
How many units should be ordered?

SOLUTION The optimal probability of the last unit being sold is

Cu 30
CPn    0.43
Cu  C o 30  40

Copyright ©2013 Pearson Education. 16

13-16
 According to the cumulative probability table (the last column in table below, 37 units should be stocked. The net benefit from stocking the 37th unit is the expected marginal profit minus the expected
marginal loss.

Demand and Cumulative Probabilities

(p) CPn
Number of Units Probability of Cumulative
Demanded This DemandProbability
35 0.10 1 to 350.10
36 0.15 36 0.25
37 0.25 37 0.50
38 0.25 38 0.75
39 0.15 39 0.90
40 0.10 40 1.00
41 0 41 or more 1.00

Copyright ©2013 Pearson Education. 17

13-17
 Marginal Inventory Analysis for Units Having Salvage Value
(N) (p) (P) (MP) (ML)
Units of Probability CPn Expected Marginal Expected Marginal
Demand of Demand Profit of n-th Unit Loss of n-th Unit (Net)
(100-70)(1- CPn-1) (70-30)CPn-1 (MP)-(ML)
35 0.10 0.10 $30 $0 $30.00
36 0.15 0.25 27 4 23.00
37 0.25 0.50 22.50 10 12.50
38 0.25 0.75 15 20 (5.00)
39 0.15 0.90 7.50 30 (22.50)
40 0.10 1.00 3 36 (33.00)
41 0 1.00 (40.00)
Note: Expected marginal profit is the selling price of $100 less the unit cost of $70 times the probability the unit will be sold.
Expected marginal loss is the unit cost of $70 less the salvage value of $30 times the probability the unit will not be sold.
Net = (MP)(1 - CPn-1 ) - (ML) CPn-1
= (1 - 0.25)($100 - $70) - (0.75) ($70 - $30)
= $22.50 - $10.00 = $12.50
For the sake of illustration, all possible decisions are shown. From the last column, we can confirm that the optimum decision is 37 units.

Copyright ©2013 Pearson Education. 18

13-18
 Newsvendor Model-
Demand Distribution Continuous

y
Critical ratio
Order y such that
CSL* = Prob(Demand < y) = Cu
Optimal Cycle
Co + Cu
Service level Critical fractile
Copyright ©2013 Pearson Education. 19
13-19
 t  z2

Newsvendor model: F (t )  
s
1
2
e 2
dz

normally distributed demand


t 2
f s (t )  1
2
e 2

Demand D ~ N(
Order y such that CSL* = Prob(Demand < y*) = Cu
Co + Cu
Let y* = +z*
y* 
Expected profit   (Cu x  Co ( y *  x)] f ( x)dx   y * Cu f ( x)dx
 y*

 (Cu  Co ) Fs ( z*)  (Cu  Co )f s ( z*)

 y * C0 Fs ( z*)  y * Cu [1  Fs ( z*)]

Copyright ©2013 Pearson Education. 20

13-20
 Optimal Cycle Service Level for
Seasonal Items – Single Order
Co: Cost of overstocking by one unit, Co = c – s
Cu: Cost of understocking by one unit, Cu = p – c
CSL*: Optimal cycle service level
O*: Corresponding optimal order size

Expected benefit of purchasing extra unit = (1 – CSL*)(p – c)

Expected cost of purchasing extra unit = CSL*(c – s)

Expected marginal
contribution of raising = (1 – CSL*)(p – c) – CSL*(c – s)
order size
Copyright ©2013 Pearson Education. 13-21
 Optimal Cycle Service Level for
Seasonal Items – Single Order

Copyright ©2013 Pearson Education. 13-22

 Optimal Cycle Service Level for
Seasonal Items – Single Order

Copyright ©2013 Pearson Education. 13-23

 Evaluating the Optimal Service Level
for Seasonal Items
Demand  = 350,  = 100, c = $100, p = $250,
disposal value = $85, holding cost = $5
Salvage value = $85 – $5 = $80
Cost of understocking = Cu = p – c = $250 – $100 = $150
Cost of overstocking = Co = c – s = $100 – $80 = $20

Copyright ©2013 Pearson Education. 13-24

 Evaluating the Optimal Service Level
for Seasonal Items

Copyright ©2013 Pearson Education. 13-25

 Evaluating the Optimal Service Level
for Seasonal Items
Expected
overstock
Expected
overstock

Expected
understock

Expected
understock

Copyright ©2013 Pearson Education. 13-26

 Evaluating Expected Overstock
and Understock
μ = 350, σ = 100, O = 450
Expected
overstock

Expected
understock

Copyright ©2013 Pearson Education. 13-27

 One-Time Orders in the Presence
of Quantity Discounts
1. Using Co = c – s and Cu = p – c, evaluate the optimal cycle
service level CSL* and order size O* without a discount
1. Evaluate the expected profit from ordering O *

2. Using Co = cd – s and Cu = p – cd, evaluate the optimal cycle

service level CSL*d and order size O*d with a discount
1. If O *
d ≥ K, evaluate the expected profit from ordering O*d
2. If O *
d < K, evaluate the expected profit from ordering K units
3. Order O* units if the profit in step 1 is higher
1. If the profit in step 2 is higher, order O *
d units if O*d ≥ K or K units if
O*d < K

Copyright ©2013 Pearson Education. 13-28

 Evaluating Service Level with Quantity
Discounts
• Step 1, c = $50
Cost of understocking = Cu = p – c = $200 – $50 = $150
Cost of overstocking = Co = c – s = $50 – $0 = $50

Expected profit from ordering 177 units = $19,958

Copyright ©2013 Pearson Education. 13-29

 Evaluating Service Level with Quantity
Discounts
• Step 2, c = $45
Cost of understocking = Cu = p – c = $200 – $45 = $155
Cost of overstocking = Co = c – s = $45 – $0 = $45

Expected profit from ordering 200 units = $20,595

Copyright ©2013 Pearson Education. 13-30

 Desired Cycle Service Level for
Continuously Stocked Items

• Two extreme scenarios

1. All demand that arises when the product is
out of stock is backlogged and filled later,
when inventories are replenished
2. All demand arising when the product is out
of stock is lost

Copyright ©2013 Pearson Education. 13-31

 Desired Cycle Service Level for
Continuously Stocked Items
Q:Replenishment lot size
S:Fixed cost associated with each order
ROP:Reorder point
D:Average demand per unit time
σ:Standard deviation of demand per unit time
ss:Safety inventory (ss = ROP – DL)
CSL:Cycle service level
C:Unit cost
h:Holding cost as a fraction of product cost per unit time
H:Cost of holding one unit for one unit of time. H = hC
Copyright ©2013 Pearson Education. 13-32
 Demand During Stockout is Backlogged

Increased cost per replenishment cycle

of additional safety inventory of 1 unit = (Q > D)H
Benefit per replenishment cycle of
additional safety inventory of 1 unit = (1 – CSL)Cu

Copyright ©2013 Pearson Education. 13-33

 Demand During Stockout is Backlogged

Lot size, Q = 400 gallons

Reorder point, ROP = 300 gallons
Average demand per year, D = 100 x 52 = 5,200
Standard deviation of demand per week, D = 20
Unit cost, C = $3
Holding cost as a fraction of product cost per year, h = 0.2
Cost of holding one unit for one year, H = hC = $0.6
Lead time, L = 2 weeks
Mean demand over lead time, DL = 200 gallons
Standard deviation of demand over lead time, L

Copyright ©2013 Pearson Education. 13-34

 Demand During Stockout is Backlogged

Copyright ©2013 Pearson Education. 13-35

 Evaluating Optimal Service Level When
Unmet Demand Is Lost
Lot size, Q = 400 gallons
Average demand per year, D = 100 x 52 = 5,200
Cost of holding one unit for one year, H = $0.6
Cost of understocking, Cu = $2

Copyright ©2013 Pearson Education. 13-36

 Yield Management
• Airline, hotel bookings
• 2 classes of customers
– high fare/revenue
– low fare/revenue
• Suppose there are infinite demand for low-fares
• Model: How many seats Q to allocate for high
fares?
C0 = LR
Cu= HR - LR
Overbooking?
Copyright ©2013 Pearson Education. 37
13-37
 Managerial levers for increased profitability
• Increase salvage value
– Sell to outlet stores, overseas
• Decrease margin lost from stockout
– Backup sourcing (e.g. competitor?)
– Rain-check, discount coupon for future purchase
• Reduction of demand uncertainty
– Improve forecasting
– Quick response
– Postponement
– Tailored sourcing

Copyright ©2013 Pearson Education. 38

13-38
 Improved Forecasts

• Improved forecasts result in reduced uncertainty

• Less uncertainty (lower R) results in either:
– Lower levels of safety inventory (and costs) for the same
level of product availability, or
– Higher product availability for the same level of safety
inventory, or
– Both lower levels of safety inventory and higher levels of
product availability
An increase in forecast accuracy decreases both the overstocked and
understocked quantity and increases a firm’s profits.

Copyright ©2013 Pearson Education. 39

13-39
 Impact of improved forecasts
Demand ~ N(350, R),
c=$100, p=$250, s=$85-$5= $80
Cost of understocking = Cu = p-c = $250-$100 = $150
Cost of overstocking = Co = c-s = $100 - $80 = $20
CSL* = Pr(D < y*) = (250-100)/(150+20)=0.88
y*=350+1.185 R

Sigma Optimal order Exp. Overstock Exp. Understock Exp. Profit

150 526 186.7 8.6 $47,469
120 491 149.3 6.9 $48,476
90 456 112 5.2 $49,482
60 420 74.7 3.5 $50,488
30 385 37.3 1.7 $51,494
0 350 0 0 $52,500

Copyright ©2013 Pearson Education. 40

13-40
 Impact of Improved forecasts

Expec
ted pro
y fit

k
rs toc
e
d ov
ecte
p
Ex dersto
ck
ed u n
ct
Ex p e


y

Copyright ©2013 Pearson Education. 41

13-41
 Quick Response
• Reduction of replenishment leadtime
• Allows for multiple orders during selling season
– Only if lead-time reduced sufficiently for additional orders to be
executed before season ends
• Increased forecast accuracy
– Forecasts more accurate closer to selling season
– Forecast based on initial demand more accurate than pre-season
forecasts

Consequences of multiple replenishments:

• Expected total quantity less for same service level
• Average overstock (for disposal) is less
• Profits are higher
Copyright ©2013 Pearson Education. 42
13-42
 Quick Response:
Multiple Orders Per Season
• Ordering shawls at a department store
– Selling season = 14 weeks
– Cost per handbag = $40
– Sale price = $150
– Disposal price = $30
– Holding cost = $2 per week
• Expected weekly demand = 20
• SD of weekly demand = D = 15

Copyright ©2013 Pearson Education. 43

13-43
 Quick Response: Multiple
Orders Per Season
• Two ordering policies
1. Supply lead time is more than 15 weeks
• Single order placed at the beginning of the season
• Supply lead time is reduced to six weeks
2. Two orders are placed for the season
• One for delivery at the beginning of the season
• One at the end of week 1 for delivery in week 8

Copyright ©2013 Pearson Education. 13-44

 Single Order Policy

Copyright ©2013 Pearson Education. 13-45

 Single Order Policy

Expected profit with a single order = $29,767

Expected overstock = 79.8
Expected understock = 2.14
Cost of overstocking = $10
Cost of understocking = $110
Expected cost of overstocking = 79.8 x $10 = $798
Expected cost of understocking = 2.14 x $110 = $235

Copyright ©2013 Pearson Education. 13-46

 Two Order Policy

Expected profit from seven weeks = $14,670

Expected overstock = 56.4
Expected understock = 1.51

$14,670 + 56.4
0 + $14,670
$29,904
Copyright ©2013 Pearson Education. 13-47
 Impact of Quick Response
Single Order Two Orders in Season
Service Order Ending Expect. Initial OUL Average Ending Expect.
Level Size Invent. Profit Order for 2nd Total Invent. Profit
Order Order
0.96 378 97 $23,624 209 209 349 69 $26,590
0.94 367 86 $24,034 201 201 342 60 $27,085
0.91 355 73 $24,617 193 193 332 52 $27,154
0.87 343 66 $24,386 184 184 319 43 $26,944
0.81 329 55 $24,609 174 174 313 36 $27,413
0.75 317 41 $25,205 166 166 302 32 $26,916

Copyright ©2013 Pearson Education. 48

13-48
 Quick Response: Multiple
Orders Per Season
• Three important consequences
1. The expected total quantity ordered during the
season with two orders is less than that with a single
order for the same cycle service level
2. The average overstock to be disposed of at the end
of the sales season is less if a follow-up order is
allowed after observing some sales
3. The profits are higher when a follow-up order is
allowed during the sales season

Copyright ©2013 Pearson Education. 13-49

 Quick Response: Multiple
Orders Per Season

Figure 13-4

Copyright ©2013 Pearson Education. 13-50

 Quick Response: Multiple
Orders Per Season

Figure 13-5

Copyright ©2013 Pearson Education. 13-51

 Two Order Policy with Improved
Forecast Accuracy

Expected profit from second order = $15,254

Expected overstock = 11.3
Expected understock = 0.30
$14,670 + 56.4
0 + $15,254
$30,488
Copyright ©2013 Pearson Education. 13-52
 Forecast Improves for Second Order (SD=3
Instead of 15)
Single Order Two Orders in Season
Service Order Ending Expect. Initial OUL Average Ending Expect.
Level Size Invent. Profit Order for 2nd Total Invent. Profit
Order Order
0.96 378 96 $23,707 209 153 292 19 $27,007
0.94 367 84 $24,303 201 152 293 18 $27,371
0.91 355 76 $24,154 193 150 288 17 $26,946
0.87 343 63 $24,807 184 148 288 14 $27,583
0.81 329 52 $24,998 174 146 283 14 $27,162
0.75 317 44 $24,887 166 145 282 14 $27,268

Copyright ©2013 Pearson Education. 53

13-53
 Postponement
Delay of product differentiation closer to time of sale.
• Prior to point of postponement, only aggregate
forecast needed (more accurate than individual
product forecasts)
• Individual forecasts more accurate close to time of
sale
• Better match of supply to demand, higher profits
• E.g. Benetton: dye  knit
• Valuable for on-line sales
• Costs?

Copyright ©2013 Pearson Education. 54

13-54
 Benetton
• Retail price p=$50, Salvage value s=$10
• 4 colours: demand for each ~ N(
• Option 1 (dye  knit): cost c=$20
– Individual forecast 20 weeks ahead
• Option 2 (knit  dye): cost c=$22
– Aggregate forecasts 20 weeks ahead
– Dye after individual demand known

Copyright ©2013 Pearson Education. 55

13-55
 Benetton
• Option 1:
– CSL* = 30/40 = 0.75
– y* = 1000 + (0.674)500 =1337
– Total production = 4(1337) = 5348
– Expected overstock =1648, Expected understock =300
– Expected profit = $94,576
• Option 2:
– CSL* = 28/40 = 0.7
– y* = 4000 + (0.524)[2(500)] =4524 =total produced
– Expected overstock =715, Expected understock =190
– Expected profit = $98,092

Copyright ©2013 Pearson Education. 56

13-56
 Value of Postponement: Benetton
• Postponement is not very effective if a large fraction
of demand comes from a single product
• Option 1
Red sweaters demand red = 3,100, red = 800
Other colors  = 300,  = 200

Expected profitsred = $82,831

Expected overstock = 659
Expected understock = 119
Copyright ©2013 Pearson Education. 13-57
 Value of Postponement: Benetton
Other colors  = 300,  = 200

Expected profitsother = $6,458

Expected overstock = 165
Expected understock = 30

Total production = 3,640 + 3 x 435 = 4,945

Expected profit = $82,831 + 3 x $6,458 = $102,205
Expected overstock = 659 + 3 x 165 = 1,154
Expected understock = 119 + 3 x 30 = 209

Copyright ©2013 Pearson Education. 13-58

 Value of Postponement: Benetton
• Option 2

Total production = 4,475

Expected profit = $99,872
Expected overstock = 623
Expected understock = 166

Postponement may not be effective with Dominant Product

Copyright ©2013 Pearson Education. 13-59
 Value of Postponement
• Better match supply and demand
– Increase profits, especially if firm produce large variety
of products with similar demand level that is NOT
positively correlated
– !! May reduce profits if there is major single product,
especially if postponement increases manufacturing
costs
• Tailored postponement
– Use postponement on uncertain demand
– Use lower-cost production on certain demand
– Segregate by product or by quantity

Copyright ©2013 Pearson Education. 60

13-60
 Tailored Postponement: Benetton

• Use production with postponement to satisfy a

part of demand, the rest without postponement
• Produce red sweaters without postponement,
postpone all others
Profit = $103,213
• Tailored postponement allows a firm to increase
profits by postponing differentiation only for
products with uncertain demand

Copyright ©2013 Pearson Education. 13-61

 Tailored Postponement: Benetton

• Separate all demand into base load and variation

– Base load manufactured without postponement
– Variation is postponed

Four colors
Demand mean = 1,000, = 500

– Identify base load and variation for each color

Copyright ©2013 Pearson Education. 13-62

 Tailored Postponement: Benetton
Table 13-4

Manufacturing Policy
Average Average Average
Q1 Q2 Profit Overstock Understock
0 4,524 $97,847 510 210
1,337 0 $94,377 1,369 282
700 1,850 $102,730 308 168
800 1,550 $104,603 427 170
900 950 $101,326 607 266
900 1,050 $101,647 664 230
1,000 850 $100,312 815 195
1,000 950 $100,951 803 149
1,100 550 $99,180 1,026 211
1,100 650 $100,510 1,008 185

Copyright ©2013 Pearson Education. 13-63

 Tailored Sourcing
Use a combination of two supply source:
– One focused on lower cost, less able to handle
uncertainty,
– One focused on flexibility but higher cost.
• Focus on different capabilities
• Better match supply to demand; increase profits
• Volume based:
– E.g. Benetton, firms with overseas suppliers
• Product based:
– E.g. Levi, traditional vs. custom jeans

Copyright ©2013 Pearson Education. 64

13-64
 Tailored Sourcing Strategies
Fraction of demand from Annual Profit
overseas supplier
0% $37,250

50% $51,613

60% $53,027

100% $48,875

Copyright ©2013 Pearson Education. 65

13-65
 Tailored Sourcing: Multiple Sourcing
Sites
Characteristic Primary Site Secondary Site
Manufacturing High Low
Cost
Flexibility High Low
(Volume/Mix)
Responsiveness High Low
Engineering High Low
Support

Copyright ©2013 Pearson Education. 66

13-66
 Dual Sourcing Strategies
Strategy Primary Site Secondary Site

Volume based Fluctuation Stable demand

dual sourcing
Product based Unpredictable Predictable,
dual sourcing products, large batch
Small batch products
Model based Newer Older stable
dual sourcing products products

Copyright ©2013 Pearson Education. 67

13-67
 Setting Product Availability for Multiple
Products under Capacity Constraints
• Single product order
• Multiple product order
• Decrease the order size
• Allocating the products
When ordering multiple products under a limited supply capacity,
the allocation of capacity to products should be based on their
expected marginal contribution to profits. This approach allocates a
relatively higher fraction of capacity to products that have a high
margin relative to their cost of overstocking.

Copyright ©2013 Pearson Education. 68

13-68
 Setting Product Availability for Multiple Products
Under Capacity Constraints
• Two styles of sweaters from Italian supplier

High end Mid-range

1 = 1,000 2 = 2,000
1 = 300 2 = 400
p1 = $150 p2 = $100
c1 = $50 c2 = $40
s1 = $35 s2 = $25
CSL = 0.87 CSL = 0.80
O = 1,337 O = 2,337
Copyright ©2013 Pearson Education. 13-69
 Setting Product Availability for Multiple Products
Under Capacity Constraints
• Supplier capacity constraint, 3,000 units
Expected marginal
contribution high-end

Expected marginal
contribution mid-range

Copyright ©2013 Pearson Education. 13-70

 Setting Product Availability for Multiple Products
Under Capacity Constraints

1. Set quantity Qi = 0 for all products i

2. Compute the expected marginal contribution MCi(Qi) for each
product i
3. If positive, stop, otherwise, let j be the product with the highest
expected marginal contribution and increase Qj by one unit
4. If the total quantity is less than B, return to step 2, otherwise
capacity constraint are met and quantities are optimal

subject to:

Copyright ©2013 Pearson Education. 13-71

 Setting Product Availability for Multiple Products
Under Capacity Constraints
Expected Marginal Contribution Order Quantity
Capacity Left High End Mid Range High End Mid Range
3,000 99.95 60.00 0 0
2,900 99.84 60.00 100 0
2,100 57.51 60.00 900 0
2,000 57.51 60.00 900 100
800 57.51 57.00 900 1,300
780 54.59 57.00 920 1,300
300 42.50 43.00 1,000 1,700
200 42.50 36.86 1,000 1,800
180 39.44 36.86 1,020 1,800
40 31.89 30.63 1,070 1,890
30 30.41 30.63 1,080 1,890
10 29.67 29.54 1,085 1,905
1 29.23 29.10 1,088 1,911
0 29.09 29.10 1,089 1,911

Table 13-5
Copyright ©2013 Pearson Education. 13-72
 Setting Optimal Levels of
Product Availability in Practice
• Use an analytical framework to increase
profits
• Beware of preset levels of availability
• Use approximate costs because profit-
maximizing solutions are very robust
• Estimate a range for the cost of stocking out
• Ensure levels of product availability fit with
the strategy
Copyright ©2013 Pearson Education. 73
13-73
 Summary
• Newsvendor model
– Tradeoff cost of over-stock and
lost sales
• Managerial levers for
increasing supply chain
profitability
– Adjust costs
– Improve forecasting
– Quick response
– Postponement Making supply meet demand!
– Tailored sourcing
• Allocate limited supply
capacity among multiple
products to maximise
expected profits

Copyright ©2013 Pearson Education. 74

13-74