Session 01 - Introduction - Cachon

Session 01 - Introduction - Cachon

Matching Supply with Demand: An Introduction to Operations Management Grard Cachon ChristianTerwiesch All slides in this file are copyrighted by Gerard Cachon and Christian Terwiesch. Any instructor that adopts Matching Supply with Demand: An Introduction to Operations Management as a required text for their course is free to use and modify these slides as desired. All others must obtain explicit written permission from the authors to use these slides. Slide 1 Low critical ratios high mismatch costs The mismatch cost is high when ((z) / (z)) is high ((z) / (z)) is high when the critical ratio is low: 2.3 2.0 1.8 (z )/ (z ) 1.5 1.3 1.0 0.8 0.5 0.3 0.0 0.05 0.15 0.25 0.35 0.45 0.55 0.65 critical ratio = C u / ( C o + C u ) Slide 2 0.75 0.85 High demand uncertainty high mismatch costs The mismatch cost is high when the coefficient of variation, /, is high. The coefficient of variation is the right measure of demand uncertainty: The probability demand is within 20% of the forecast demand depends on the coefficient of variation (COV) and not the standard deviation: Normal demand, = 60 1.0

1.0 0.9 0.9 0.8 0.8 0.7 0.7 0.6 0.6 Probability Probability Normal demand, = 20, = 10, COV =0.5 31% 0.5 0.4 0.3 0.2 0.2 20% 31% 0.4 0.3 0.1 95% 0.5 = 30 COV = 30 / 60 = 0.5 = 10 COV = 10 / 60 = 0.17 20% 0.1 0.0 0.0 0 4 8 12 16

20 24 28 32 36 10 40 20 30 40 50 60 Demand Demand Slide 3 70 80 90 100 110 Find your products mismatch cost (as % of maximum profit) Critical ratio Coefficient of variation 0.10 0.25 0.40 0.55 0.70 0.85 1.00 0.4 10% 24% 39% 53% 68% 82% 97% 0.5 8% 20% 32% 44% 56% 68%

80% 0.6 6% 16% 26% 35% 45% 55% 64% Slide 4 0.7 5% 12% 20% 27% 35% 42% 50% 0.8 3% 9% 14% 19% 24% 30% 35% 0.9 2% 5% 8% 11% 14% 17% 19% Unlimited, but expensive reactive capacity Generate forecast of demand and submit 1st order to TEC Oct Receive 1st order from TEC at the end of Jan Nov Dec Jan Spring selling season (Feb Jul) Feb Mar Apr May Jun Receive 2nd order from TEC at the end of Apr Observe Feb and Mar sales and submit 2nd order to TEC

Jul Aug Left over units are discounted TEC charges a premium of 20% per unit ($132 vs. $110) in the second order. There are no restrictions imposed on the 2nd order quantity. ONeill forecast of total season sales is nearly perfect after observing initial season sales. How many units should ONeill order in October? Slide 5 Limited reactive capacity Generate forecast of demand and submit 1st order to TEC Oct Nov Dec Jan Observe prebook orders from retailers Receive both orders from TEC at the end of Jan Spring selling season (Feb Jul) Feb Mar Apr May Jun Submit 2nd order to TEC Jul Aug Left over units are discounted Units in the 2nd order are no more expensive than in the 1st order But there is limited capacity for a 2nd order Slide 6 Sample of wetsuits Sport Model DIVE DIVE COMP 3/2 FULL DIVE WMS 7000X 7MM FULL SURF EPIC 5/3 W/HD SURF HEAT 3/2

SURF HEATWAVE 4/3 SURF ZEN-ZIP 4/3 TRIATHLON TRIATHLON 4/3 FULL WAKE-BOARD REACTOR 3/2 WINDSURF CYCLONE 4/3 WINDSURF WMS EVOLUTION 4/3 = expected demand = standard deviation of demand 1100 660 600 360 800 296 1200 444 700 259 3100 1147 2600 1690 1500 750 950 665 850 595 0.60 0.60 0.37 0.37 0.37 0.37 0.65 0.50 0.70 0.70 Price Margin Discount 120 275 225 110 140 165 210 150 325 275 38% 38% 38% 38% 38% 38% 45% 45% 45% 45% 65% 65% 50%

50% 50% 50% 65% 65% 65% 65% Price = wholesale price Margin = gross margin as a % of price Discount = anticipated end of season discount as % of price to sell left over inventory 1st order must be at least 10,200 suits so that there is enough capacity for the 2nd order. What should we produce in the 1st order? Slide 7 Profit and mismatch with only 1 ordering opportunity Use the Newsvendor model to evaluate the optimal order quantity, expected profit, maximum profit and mismatch cost Sport DIVE DIVE SURF SURF SURF SURF TRIATHLON WAKE BOARD WINDSURF WINDSURF Total Model DIVE COMP 3/2 FULL WMS 7000X 7MM FULL EPIC 5/3 W/HD HEAT 3/2 HEATWAVE 4/3 ZEN-ZIP 4/3 TRIATHLON 4/3 FULL REACTOR 3/2 CYCLONE 4/3 WMS EVOLUTION 4/3 Order quantity 1241 677 1009 1514 883 3910 3449 1877 1284 1149 16993

Expected Maximum Mismatch profit profit cost $30,086 $50,160 $20,074 $37,608 $62,700 $25,092 $58,048 $68,400 $10,352 $42,568 $50,160 $7,592 $31,604 $37,240 $5,636 $164,953 $194,370 $29,417 $164,582 $245,700 $81,118 $75,536 $101,250 $25,714 $89,538 $138,938 $49,399 $67,788 $105,188 $37,399 $762,311 $1,054,105 $291,794 A suits produced in the 1st order earns the Newsvendor profit but a suit produced in the 2nd order earns the maximum profit. Slide 8 Produce safer products early, produce risky products with reactive capacity Sort items by their mismatch cost to order quantity ratio. Fill the 1st order up to the minimum quantity (10,200) with the items that have the lowest mismatch quantity ratio Order quantity Model HEAT 3/2 1514 HEATWAVE 4/3 883 ZEN-ZIP 4/3 3910 EPIC 5/3 W/HD 1009 REACTOR 3/2 1877 DIVE COMP 3/2 FULL 1241 TRIATHLON 4/3 FULL 3449 WMS EVOLUTION 4/3 1149 WMS 7000X 7MM FULL 677 CYCLONE 4/3 1284 Total 16993

Newsvendor expected Mismatch profit cost $42,568 $7,592 $31,604 $5,636 $164,953 $29,417 $58,048 $10,352 $75,536 $25,714 $30,086 $20,074 $164,582 $81,118 $67,788 $37,399 $37,608 $25,092 $89,538 $49,399 $762,311 $291,794 The mismatch cost is reduced by 66%! Slide 9 Mismatch costorder quantity First order ratio quantity Profit 5.0 1514 $42,568 6.4 883 $31,604 7.5 3910 $164,953 10.3 1009 $58,048 13.7 1877 $75,536 16.2 1241 $30,086 23.5 0 $245,700 32.6 0 $105,188 37.1 0 $62,700 38.5 0 $138,938 10434 $955,320 $1,100,000 $1,050,000 $1,000,000 Profit $950,000 $900,000 $850,000 $800,000 $750,000 $700,000 0 2500 5000

7500 10000 12500 15000 17500 Total quantity in the initial order Slide 10 0 0.45 0 0.40 0.7 0.6 0.5 0.4 0.3 0.2 0.1 Slide 11 CYCLONE 4/3 WMS 7000X WMS EVO TRIA 4/3 DIVE COMP 3/2 REACTOR 3/2 EPIC 5/3 ZEN-ZIP 4/3 0.8 WMS 7000X 0.70 HEAT 4/3 120 WMS EVO 0.75 HEAT 3/2 60 Critical ratio 140 TRIA 4/3

CYCLONE 4/3 WMS 7000X WMS EVO TRIA 4/3 0.80 CYCLONE 4/3 20 DIVE COMP 3/2 80 DIVE COMP 3/2 0.50 REACTOR 3/2 100 REACTOR 3/2 EPIC 5/3 ZEN-ZIP 4/3 HEAT 4/3 HEAT 3/2 Coefficient of variation 40 EPIC 5/3 ZEN-ZIP 4/3 HEAT 4/3 HEAT 3/2 Gross margin ($) 160 0.65 0.60 0.55

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