International Operations Management

MGMT 6367

Lecture 04

Instructor: Yan Qin

Fall 2013

Outline – Supply Chain Management

Push, Pull, and Push-Pull systems

Distribution Strategies

Design for Supply Chain efficiency

Supply Chain ContractsBuy Back contracts

Quantity Discount s

More Supply Chain contracts

Cycle inventory

Push-based Supply Chain

In a push-based supply chain, production and distribution decisions are based on demand forecasts.

Products are pushed from upstream to downstream.

Pull-Based Supply Chain

In a pull-based supply chain, production and distribution are demand driven so that they are coordinated with true customer demand rather than forecast demand.

Push Vs. Pull

Area Push system Pull system

Response time to changes in demand

Slow, may lead to lost sales when there is upturn and inventory obsolescence when demand drops

Quick, demand driven

Product customization

Difficult Relatively easy

Demand Variability to upstream members

High Low

Inventory level High Low (no inventory in a pure pull system)

Economies of scale

Yes Often difficult due to small batches

Implementation Easy, just build inventory

Difficult

Push-Pull Supply Chain

In a push-pull system, some stages of the supply chain, usually the initial stages, such as supplier and manufacturer, are operated in a push-based manner while the remaining stages employ a pull-based strategy.

Distribution Strategies

Three common outbound distribution strategies:Direct shipment: Products are shipped

directly from supplier to the retail stores.

Warehousing: Classical strategy in which warehouses keep stock and fulfill orders from the retailer.

Cross-docking: Products are distributed continuously from suppliers through warehouses to customers. But the warehouse rarely keep the products for more than 10 to 15 hours.

Direct Shipment

Direct shipment is common for large retailers, which requires fully loaded trucks.

Advantages Disadvantages

Avoid of the expense of operating a distribution center

Higher transportation costs if shipments are small and the supplier serves a number of retailers

Reduced lead time

Cross-docking

In cross-docking, the warehouse is used as an inventory coordination point rather than as an inventory storage point.

The implementation of cross-docking requires:A significant start-up investment;

Retailers and suppliers must be linked with advanced information systems, such as at Wal-Mart.

A fast and responsive transportation system.

Effective only for large distribution systems in which a large number of vehicles are delivering and picking up at any one time.

Design product for Supply Chain efficiency

Product design used to be an independent function isolated from manufacturing and logistics.

Design for manufacturability (DFM) movement:The link between product design and

manufacturing was established out of the need to know why products fail and how to minimize the failure.

It was recognized that product reliability is closely linked with product design.

DFM is also called concurrent engineering

Design product for Supply Chain efficiency

Design for Logistics (DFL)Innovative product designs appear that

take logistics considerations into account.

Two significant ways that logistics considerations enter into product design phase:Product design for efficient transportation and

shipment

Delayed differentiation to take advantage of benefits such as economies of scale.

Allocation of Supply Chain Profits

With respect to the allocation of supply chain profit, firms should care about two things:

The size of a firm’s piece of the “pie”, where the pie refers to the supply chain’s total profit;

The size of the total “pie”.

Buy-back Contracts

Buy-back contracts introduce new costs into the supply chain since the original buyer will need to ship the leftover inventory back to the original supplier.

Buy-back contracts may also generate new revenue as the supplier may be able to resell the leftover to another buyer, possible at another location.

What can be some other possible reasons for a supplier to accept returns from a buyer?

More Supply Chain Contracts

Three common-type of quantity discount supplier pricing:Linear Quantity Discount

This quantity discount scheme assumes that a supplier offers a price that decreases in the quantity ordered by a retailer.

Let t be some constant discount rate and be the base price.

Unit price for order quantity Q:

Linear Quantity Discount

All-unit Quantity Discount

All-unit Quantity Discount

The unit price offered by a supplier declines on a step function basis. Define as a set of alternative unit prices such that

And let be a set of quantities, called break points, such that

Set

Then the all-unit quantity discount can be expressed as

All-Unit Quantity Discount

Unit cost

Incremental Quantity Discount

Incremental Quantity Discount

Under incremental quantity discounts, discounts are only applied to additional units beyond the breakpoints. The unit cost/price for the quantity interval decreases as increases.

The average unit cost/price can be calculated as follows:

,

for

for

The unit discounted price is just the total purchase cost divided by the order quantity.

Example

Suppose a trash bag company charges based on an incremental scheme. Specifically, it charges 30 cents per bag for the first 500 bags, 29 cents for all units beyond.

Then for orders of no more than 500 bags, what is the average cost?

For orders of less than 1001 bags but more than 500, what is the average cost?

Incremental Quantity Discount

Example: Quantity Discount

Suppose a store has been given an all-unit quantity discount schedule for a product. The normal cost for the product is $5. For orders between 1001 and 2000 units, the unit cost drops to $4.8; for orders of 2001 or more units, the unit cost is only $4.75. The store expect the sales for that product in the next month to be 2500. How much does it pay?

Now how much does the store pay if it is offered an incremental quantity discount scheme with the same quantity break points as stated above. The price is $5 for orders no greater than 1000. For the next additional 1000 units, the unit price becomes $4.8. For any additional units above 2000, the price drops to $4.75. What is the purchasing cost?

Comments:

Note that the average cost/price per unit with an all-unit schedule will be less than the average cost per unit with the corresponding incremental schedule.

Notice the irrationality of the all-unit schedule? In the example, 1,000 units would cost $5,000, whereas 1,001 units would only cost $4,804.8. This is an incentive for a buyer to purchase more.

More Supply Chain Contracts

Options ContractsWith an options contract, a buyer pays a

price to purchase options and another price to exercise the purchased options.

Revenue SharingWith revenue sharing, a buyer pays a

wholesale price to the supplier but then also pays a portion of the revenue earned.

More Supply Chain Contracts

Quantity Flexibility ContractsSuppose a buyer and a supplier agree upon

a 25% Quantity Flexibility Contract.

Price ProtectionWith price protection, a supplier

compensates the buyer on remaining inventory for any price reduction.

Green Supply Chain

A fully developed green supply chain considers sustainability for every participant at every step, from product design to production, transportation, storage, consumption, to eventual disposal or recycling.

The objective is to reduce waste, mitigate legal and environmental risks, minimize or eliminate adverse health impacts, improve the reputations of companies and their products, and enable compliance with increasingly stringent regulations and societal expectations.

Next: Cycle Inventory

We will next discuss

1. How to choose the optimal lot size and cycle inventory to minimize the related costs in a supply chain using the Economic Order Quantity model; and

2. Quantify the impact of quantity discounts on lot size and cycle inventory.

Cycle Inventory

A lot or batch size is the quantity that a stage of a supply chain either produces or purchases at a time.

Cycle inventory is the average inventory in a supply chain due to either production or purchases in lot sizes that are larger than those demanded by the customer.

Let’s start with the simplest situation…

Suppose (1) there is no uncertainty in demand and (2) order lead time is zero.

For effective inventory control in this overly simplified situation, Ford W. Harris introduced the Economic Lot Size model, or Economic Order Quantity (EOQ) model, in 1915.

The EOQ model illustrates the tradeoff between the setup cost and inventory holding cost.

EOQ Model

Three types of costs are considered in the EOQ model:Purchasing cost per unit, that is, selling

price, denoted as C

Setup cost, which is the fixed cost incurred by order placement, denoted as K (aka, ordering cost)

Inventory holding cost per unit per year, denoted as h

The objective is to minimize the sum of the three types of costs on an annual basis.

EOQ Model

Let D denote the annual demand and Q denote the order quantity. Then the total annual cost can be expressed as

Economic Order Quantity

Using a little calculus, the order quantity that minimizes the total annual cost is

Cycle Inventory under EOQ model

When demand is steady, cycle inventory and lot size are related as follows:

Cycle inventory =

Therefore, under the EOQ model, is the optimal cycle inventory level that minimizes the total cost.

Example: EOQ & Cycle Inventory

Consider a hardware supply warehouse that is contractually obligated to deliver 52,000 units of a fastener to a local manufacturer in a year. Each time the warehouse places an order from its suppliers, an ordering and transportation fee of $20 is charged. The warehouse pays $1 per each fastener. Annual inventory holding cost is 25% of the unit inventory value, or $0.25 per year.

The warehouse manager would like to know how much to order each time when the inventory gets to zero.

And what is the resulted cycle inventory level?

Impact of quantity discounts

We now consider pricing schedules that encourage buyers to purchase in large lots.

The buyer’s objective is to select lot sizes to minimize the total annual material, order, and holding costs when given a quantity discount.

Find the optimal lot sizing response

To find the optimal lot size under an all-unit quantity discount, we need to evaluate the optimal lot size for each price and pick the one that minimizes the overall cost.

Step 1: Evaluate the optimal lot size for each price, , as follows.

Find the optimal lot sizing response

Step 2: We next select the order quantity * for each price . There are three possible cases for

Case 3 can be ignore, since it is for .

In Case 1, we set ;

In Case 2, we set = to take advantage of the quantity discount.

Find the optimal lot sizing response

Step 3: For each , calculate the resulted total annual cost as follows:

Total cost,

Step 4: Select the with the lowest total cost.

Example: EOQ under all-unit discount

The demand for a product is 10,000 bottles per month. The fixed ordering cost incurred at the buyer’s place is $100 per order and the inventory holding cost is 20%. The seller uses the following all unit discount scheme.

What is the optimal order quantity or lot size in this case?

Quantity breaks

Unit Price

0 – 4,999 $3.00

5,000 – 9,999 $2.96

10,000 and more

$2.92

Next Week

Production Facility Layouts◦ Basic production Layouts

◦ Suitable products for each layout

◦ Design of Process Layout CRAFT Systematic Layout Planning

◦ Design of Assembly Line Assembly line balancing How to speed up