MANAGING ECONOMIES OF SCALE eVCLE INVENTORY TO WHAT IS ECONOMIES OF SCALE? WHAT IS INVENTORY?ECONOMIES OF SCALE ECONOMIES OF SCALE ® Level of operations that recovers the fixed cost. = Level of operation can be Production, Sales or Stock etc.Stock/material (in the form of Raw Material, In process or as finished good) that is stored for future use INVENTORY @ Stock/material (in the form of Raw Material, In process or as finished good) that is stored for future use 'ycle inventory is the average inventory ina supply chain due to either production or purchases in lot sizes that are larger than those demanded by the customer Q: Quantity in a lot or batch size D: Demand per unit time ANOLNAANI GNYWaGdINVENTORY © Stock/materi ° Faw t laterial, Lot or batch size is the quantity Pitta telco supply chain either produces Clee ee) atts GNwwad 314OUd AMOLNAANIAnventary e ime Fiewot lot size_ Cycle inventor g yi y= aS average inventory Average flow time = average flow rate Average flow time resulting from cycle inventory "_oycle inventory __O- demand Rear rere ets Average flow time resulting from cycle inventory “_oycle inventory __O demand 2D 3140Ud AYOLNIANI NIVHD Alddfs ¥ NI AMOLNJANI SIDA JO JTOUAnventary rele Seven-Eleven, and ‘Average flow ti ats) Average flow ti resulting from cycle inventory "_oycle inventory _ O- demand re UN RAI CRC) + Reduce costs in the supply chain gure Cycle inventory = lotsize_ rane average inventory ‘Average flow time = average flow rate Average flow time resulting from cycle inventory "_oycle inventory __ 0 demand 2D NIVHD Alddfs ¥ NI AMOLNAANI SIDAD JO JTOU = W NI AVQLNSANI 319AD 4O J10U NIVHD Aldds- Average price paid per unit purchased is a key cost in the lot-sizing decision Material cost = C - Fixed ordering cost includes all costs that do not vary with the size of the order but are incurred each time an order is placed Fixed ordering cost = S - Holding cost is the cost of carrying one unit in inventory for a specified period of time Holding cost = H = hC Primary role of cycle inventory is to allow different stages to purchase product in lot sizes that minimize the sum of material, ordering, and holding costs eldeally, cycle inventory decisions should consider costs across the entire supply chain ln practice, each stage generally makes its own supply chain decisions © Increases total cycle inventory and total costs ‘in the supply chain NIVHD Alddfs NIVHD Aldds VY NI AMOLNZANI JIDAD JO FIOU = NI ANOLNJANI F1DAD JO 310¥Economies of scale exploited in three typical situations 1. A fixed cost is incurred each time an order is placed or produced 2, The supplier offers price discounts based on the quantity purchased per lot 3. The supplier offers short-term price discounts or holds trade promotions NIVHD Alddns VW NI AYOLNIANI 319A9 JO 3104 ESTIMATING CYCLE INVENTORY RELATED COSTS JN PRACTICEESTIMATING CYCLE INVENTORY RELATED COSTS IN PRACTICE ECONOMIES OF SCALE TO EXPLOIT FIXED COSTS + Lot sizing for a single product (E0Q) D = Annual demand of the product S. = Fixed cost incurred per order C = Cost per unit H_ = Holding cost per year as a fraction of product cost » Basic assumptions ~ Demand is steady at D units per unit time No shortages are allowed ~ Replenishment lead time is fixedECONOMIES OF SCALE TO EXPLOIT FIXED COSTS © Minimize « Annual material cost = Annual ordering cost * Annual holding cost LOT SIZING FOR A SINGLE PRODUCT Annual material cost = CD Number of orders per year = a + D ‘Annual ordering cost -(2}s ‘Annual holding cost -(2)-(2 hrc Total annual cost, TC = cvs[2)s-{3)rcLOT SIZING FOR A SINGLE PRODUCT Cost Total Cost a La Size LOT SIZING FOR A SINGLE PRODUCT * The economic order quantity (EOQ) Ds Optimal lot size, * = =~ * The optimal ordering frequency + D _ [Ie nite = [DRC o* \2sDemand for Deskpro computer at best buy is 1000 units per month. Best buy incur a fixed order placement, transportation and receiving cost § 4000 each time an order is placed. Each computer costs Best buy $ 500 and the retailer has a holding cost of 20 percent. Find the number of computer that a manager replenishes each time. EOQ EXAMPLE Annual demand, D = 1,000 x 12 = 12,000 units Order cost per lot, S = $4,000 Unit cost per computer, C = $500 Holding cost per year as a fraction of unit cost, = 0.2 2 12,000 x 4,000 500 Optimal order size = 0* T1dWvXa 003Q* _ 980 Cyele inventory = 2" = £0 _ 490 Number of orders per year per 228 ‘Annual ordering and holding vost Ps. [ 2 nes 97,980 ‘Average flow time = 2° = 490 _ 9.941=0.49 month 2D 12,000 ; Q* _ 980 Cyele inventory = 2° = 980. "Ae Number of orders per year = oe 12.24 Close to EOQ is the key than Precise EOQ TidwvxXa 003 TIdwvxa 003EOQ EXAMPLE * Lot size reduced to Q = 200 units ‘Annual inventory-related costs = e [2 nc = 250,000 LOT SIZE AND ORDERING COST © If the lot size Q* = 200, how much should the ordering cost be reduced? Desired|ot size, O° = 200 Annual demand, D = 1,000 « 12 = 12,000 units Unit cost per computer, C = $500 Holding cost per year as a fraction of inventory value, f= 0.2 sa = = 166.7 SWIL MOTI JINGIY OL©The entire lot does not arrive at the same time Production occurs at a specified rate P @ Inventory builds up at a rate of P- D Annual setup cost Annual holding cost / D Or: (S}s a-v1n| rc ONIZIS LO NOLLONGOUd Aggregating replenishment orders across products, retailers or suppliers in a single order allows for reduction in lot size for individual products because fixed ordering and transportation costs are ne spread across multiple products, retailers or suppliers. 2 a } a a) =] =Demand for 4 computer model at best buy is 1000 units per month. Best buy incur a fixed order placement, transportation and receiving cost $ 4000 each time an order is placed. Each computer costs Best buy $ 500 and the retailer has a holding cost of 20 percent. Find the number of computer that a manager replenishes each time. _ PDs “Vac @ Without aggregation: © With aggregation: all models are replenished in a single model. EQ = 980 units Order cost = 4000; Demand = as a separate order are 4x1000x12; holding cost = 0.2x500 initiated by each manager of a model E0Q = 1960 units over all products £0Q for each product = 1960/4 = 490 Savings in transportation costs = Reduces fixed cost for each product * Lot size for each product can be reduced * Cycle inventory is reduced @ Single delivery from multiple suppliers or single truck delivering to multiple retailers © Receiving and loading costs reduced 3) 1 AAP 1O hy ER ee! 2 » } a y 7 a 3 =} aLOT SIZING WITH MULTIPLE PRODUCTS OR CUSTOMERS * Ordering, transportation, and receiving costs grow with the variety of products or pickup points * Lot sizes and ordering policy that minimize total cost Dz: Annual demand for product i 5S: Order cost incurred each time an order is placed, independent of the variety of products in the order si Additional order cost incurred if product i is included in the order LOT SIZING WITH MULTIPLE PRODUCTS OR CUSTOMERS © Three approaches 1, Each product manager orders his or her model independently 2, The product managers jointly order every product in each lot 3. Product managers order jointly but not every order contains every product; that is, each lot contains a selected subset of the productsMULTIPLE PRODUCTS ORDERED AND DELIVERED INDEPENDENTLY Best buy sells three models of computers, litepro, medpro, and heavypro. Annual Demand for three products are D, = 12,000/yr, Dy = 1,200/yr, Dy = 120/yr. Each model costs Best buy $500. A fixed transportation cost of $ 4000 is incurred each time an order is delivered. For each model ordered and delivered on the same truck, an additional fixed cost of $1000 per model is incurred for receiving and storing. Best buy holding percentage is 20% a1dWvxa MULTIPLE PRODUCTS ORDERED AND DELIVERED INDEPENDENTLY Demand Dz = 12,000/yr, Dyy= 1,200/yr, Dy = 120/yr Common order cost S= $4,000 Product-specific order cost 51, = $1,000, s5,= $1,000, s,, = $1,000 Holding cost h=0.2 Unit cost Cy = $500, C= $500, Cy, = $500 JTdWVxXSMULTIPLE PRODUCTS ORDERED AND INDEPENDENTLY Litepro Demand per year 172,000 Fixed cost/order $5,000 Optimal order size 1,095 ‘cycle inventory 548 ‘Annual holding cost srr ‘Order frequency 11.0/year ‘Annual ordering cost $94,772 ‘Average flow time 2aAweeks Annual cost $109,544 Medpro 7,200 $5,000 346 1B 917,321 3.S/year $17,321 7.5 weeks $34,642 * Total annual cost = $155,140 LOTS ORDERED AND DELIVERED JOINTLY Annual order cost = S* StESt5, 45,455 Annual holding cost = 2n DAC, cerns 2n DiC, + DyhC,, +DyhCy 2s Total annual cost = D,hC, in PyhCy 2n Heavypro 120 $5,000 110 5 99,477 Alyear 99,477 23.7 weeks $10,954 DyhCy , DyhCy DyhCy , PubCy 2n AC, ww Stn 2n ‘25° DiwDhC, LIVERED a1dWvxaPRODUCTS ORDERED AND DELIVERED JOINTLY S*=S+s, +5, +5, =$7,000 per order 12,000 «100 +1,200100= 120100 _9 75 27,000 . Annual order cost = 9.75 x 7,000 = $68,250 Annual ordering and holding cost = $61,512 + $6,151 + $615 + $68,250 = $136,528 UCTS ORDERED AND DELIVERED JOINTLY Litepro_Nedpro__Heavypro Demand per year (D) 712,000 7,200 120 Order frequency (n+) 9.75/year— 9.75/year 9.75 /year Optimal order size (D/1) 1,230 1 123 cycle inventory 615 ons 6.15 Annual holding cost $61,512 $6,151 5615 Average flow time 2.67 weeks 2.67 weeks 2.67 weeks a1dWvxa JTdWVxXSAGGREGATION WITH CAPACITY CONSTRAINT + WWW. Grainger sources for hundred of suppliers and is considering the aggregation of inbound shipments to lower costs. Truckload shipping cost $500 per truck along with $100 per pickup. Average annual demand from each supplier fs 10000 units. Each unit costs $50 and Grainger incurs a holding cost is 20% of unit price. What is optimal order frequency an size if Grainger decides to aggregate four supplier per truck?. What is the optimal order size and frequency if each truck has a capacity of 2500 units? AGGREGATION WITH CAPACITY CONSTRAINT - W.W. Grainger example Demand per product, D; = 10,000 Holding cost, h = 0.2 Unit cost per product, C; = $50 Common order cost, S = $500 Supplier-specific order cost, s; = $100 a1dWvxa JTdWVxXSAGGREGATION WITH CAPACITY CONSTRAINT S*=S+5,+5, +5, +5, =$900 per order * DAC, DiwPACy _ [4x10,000x0.2*50 _ 44 94 25" 2% 900 Annual order cost = 14.91 ae = $3,354 Annual holding _ CO _ 9 ,.59,.871_ 53.356 cost per supplier 20” 2 : AGGREGATION WITH CAPACITY CONSTRAINT Total required capacity per truck = 4 x 671 = 2,684 units Truck capacity = 2,500 units Order quantity from each supplier = 2,500/4 = 625 Order frequency increased to 10,000/625 = 16 ‘Annual order cost per supplier increases to $3,600 Annual holding cost per supplier decreases to $3,125. a1dWvxa JTdWVxXSLOTS ORDERED Al DELIVERED JOINTLY FOR A SELECTED SUBSET Litepro__Medpro_Heavypro ‘Demand per year (D) 12,000 1,200 120 Order frequency (n+) 9.75/year 9.75/year —_9.75/year Optimal order size (D/n*) 1,230 123 123 cyte inventory 615 615 615 Annual holding cost $61,512 96,151 $615 Average flow time 267 weeks 2.67 weeks _ 2.67 weeks LOTS ORDERED AND DELIVERED JOINTLY FOR A SELECTED SUBSET Litepro_Wedpro_Heavypra Demand per year (D) 12,000 1,200 20 Order frequency (ns) 9.75/year —9.75/year_ 9.75 /year Optimal order size (D/n) 1,230 123 123 cycle inventory 615 615 6.5 Annual holding cost $61,512 $6,151 9615 average flow time 2.67 weeks 2.67 weeks _ 2.67 weeksLOTS ORDERED AND DELIVERED JOINTLY FOR A Uitepro__Nedpro ‘Demand per year (D) 12,000 7,200 20 Order frequency (n+) 9.75/year —9.7S/year 9.75 /year Optimal order size (D/nr) 1,230 123 123 Cycle inventory 615 615 6.5 Annual holding cost $61,512 $6,151 $615 Average flow time 267 weeks 2.67 weeks 2.67 weeks Heavypro with demand 120/year is alto ordered 9.75 time ina year. This fs extentally Incurting $81.25 Additonal in order cost each time a order f placed, It Heavypro is ordered in every 42 order (Instead of every order), $7312.50 [=9.75x1000%(3/4)] wil be saved in product specific ordering cost, This essentially increases the holding cst as order size Increases. Holding cost increases to $1846.15 [=30040.23((12019.73972}x3], (Overall saving = 7312.50 - 1846.1 = $5466.40 LOTS ORDERED AND DELIVERED JOINTLY FOR A SELECTED SUBSET Step 1: Identify the most frequently ordered product assuming each product is ordered independently ACD, 2S +5) Step 2: For all products = i*, evaluate the ordering frequency VsLOTS ORDERED AND DELIVERED JOINTLY FOR A SELECTED SUBSET Step 3: For all i =/*, evaluate the frequency of product i relative to the most frequently ordered product i* to be m, ain| ne] Step 4: Recalculate the ordering frequency of the most frequently ordered product i* to ben LOTS ORDERED AND DELIVERED JOINTLY FOR A SELECTED SUBSET Step 5: Evaluate an order frequency of n, = n/m, and the total cost of such an ordering policy ho re-ns+¥ng +>{ 2c Ake, Tailored aggregation - higher-demand products ordered more frequently and lower-demand products ordered less frequentlyORDERED AND DELIVERED JOINTLY - FREQUENCY VARIES BY ORDER © Applying Step 1 = [ACP 14.0 \255,) ae w=11.0 i= (LGPw 23.5 M126 +8.) ORDERED AND DELIVERED JOINTLY - FREQUENCY VARIES BY ORDER © Applying Step 2 Te [ka arr ond To Pee m2 2s, 2s, * Applying Step 3ORDERED AND DELIVERED JOINTLY - FREQUENCY VARIES BY ORDER © Applying Step 4 * Applying Step 5 n, =11.47,ny =11.47/2=5.74andn, =11.47/5=2.29 Annual order cost, Total annual cost MS+1,8, + My Syp + MySy = 3O5,383.5 $130,767 ORDERED AND DELIVERED JOINTLY - FREQUENCY VARIES BY ORDER Litepro_Nedpro__Heavypro Demand per year (D) 712,000 7,200 120 Order frequency (n+) M.A7/year—S.7élyear 2.29 /year Optimal order size (D/1) 1,046, 209 2 cycle inventory 523 104.5 2% Annual holding cost $52,307 $10,461 $2,615 Average flow time 2.27 weeks 4.53 weeks _ 11.35 weeksECONOMIES OF SCALE TO EXPLOIT QUANTITY DISCOUNTS © Lot size-based discount - discounts based on quantity ordered in a single lot © Volume based discount - discount is based on total quantity purchased over a given period © Two common schemes «= AlLunit quantity discounts = Marginal unit quantity discount or multi-block tariffs QUANTITY DISCOUNTS © Two basic questions 1. What is the optimal purchasing decision for a buyer seeking to maximize profits? How does this decision affect the supply chain in terms of lot sizes, cycle inventories, and flow times? 2. Under what conditions should a supplier offer quantity discounts? What are appropriate pricing schedules that a supplier seeking to maximize profits should offer?ALL-UNIT QUANTITY DISCOUNTS Pricing schedule has specified quantity break POINES Go, G4» +s Gp» Where qo =O olf an order is placed that is at least as large as q, but smaller than g,,;, then each unit has an average unit cost of C, © Unit cost generally decreases as the quantity increases, i.€., Cy> C; >.> C, @ Objective is to decide on a lot size that will minimize the sum of material, order, and holding costs -UNIT QUANTITY DISCOUNTS Average Cost per Unit Purchased 0 4% gy Quantity Purchased Pwe 113ALL-UNIT QUANTITY DISCOUNTS Step 1: Evaluate the optimal lot size for each price C,,0 < is ras follows 2DS @-Vie ALL-UNIT QUANTITY DISCOUNTS Step 2: We next select the order quantity 0*, for each price C, 1. GS2 q, = 5,000 For i= 1,2 Q; = Q, = 6,367; 0, = ¢, = 10,000 ALL-UNIT QUANTITY DISCOUNT EXAMPLE Step 3 Tc, =| ( 7 Js 1 Shee = $368,969, TC, = $354,520 Lowest total cost is for /=2 Order Q; = 10,000 bottles per lot at $2.92 per bottleMARGINAL UNIT QUANTITY DISCOUNTS + Multi-block tariffs - the marginal cost of a unit that decreases at a breakpoint For each value of i, 0 q,, then set 9 MARGINAL UNIT QUANTI DISCOUNTS Step 3: Calculate the total annual cost of ordering 0," re -|2fselr-sta aye ve ¥+(/-4)c] Step 4: Select the order size Q,* with the lowest total cost TC,MARGINAL UNIT QUANTITY DISCOUNT EXAMPLE © Original data now a marginal discount Order Quantity Unit Price 04,999 $3.00 5,000-9,999 52.96 10,000 or more $2.92 go = 0, qi = 5,000, gz = 10,000 Co = $3.00, C, = $2.96, Cz = $2.92 D = 120,000/year, $= $100/lot, h = 0.2 MARGINAL UNIT QUANTITY DISCOUNT EXAMPLE ¥,=0, V,=3(6,000-0)=$15,000 ¥, = (5,000 — 0) +2.96(10,000 — 5,000) = $29,800 Step 1 [2D(S+¥,—a9Co) 0, = [LPS Vo d0o) _ 6.324 ‘ AC,MARGINAL UNIT QUANTITY DISCOUNT EXAMPLE Step 2 Q 5,000 because Q, = 6,324 > 5,000 0; = 4,=10,000; 0, = 0, = 16961 Step 3 --|2. +(Q; - + Pr, +19; - l=! re,-[2 sr (Oi ~acJn!2+ FF, 0-0, ]-$963,900 re-[2 sar scape, 2+ Bln se aye )-s0nren TC, {2st H@,-ane,]h12+ Fr 410, ~4,)C,|-$360,365, MARGINAL UNIT QUANTITY DISCOUNT EXAMPLE Step 2 @;, = 4, =5,000 because @, = 6,324 > 5,000 9; = 4, =10,000; 9, = 0, = 16,961 Step 3 eeeWHY QUANTITY DISCOUNTS? © Quantity discounts can increase the supply chain surplus for the following two main reasons 1. Improved coordination to increase total supply chain profits 2, Extraction of surplus through price discriminationQUANTITY DISCOUNTS FOR COMMODITY PRODUCTS 20,000 bottles/year, Sq = $100, hy = 0.2, Cy = $3 Sy= $250, hyy= 0.2, 2DS, _ {2x120,000%100 = 2 | —_— = 6,325, ox AC 0.2%3 a Annual cost toroo-( s, +f Be, =33.795 2, \2 {)s,+(2)rcu= Anmalosormamicne | 2), {jc =86008 Annual supply chain cost. _ H i {manufactarers DO) = 96009 + $3,795 = $9,803 LOCALLY OPTIMAL LOT SIZES In case manufacturer produces at a rate that matches demand, Annual cost for DO {2}: { \ and manufacturer ~\o, ‘Annual cost tor00-{ 2s, a Me, =$4,059 PPD Arnal xe ormantasurer-| 2s, (2°), +8806 Annual supply chain cost _ : - (imanufacterers DO) = 95106 + $4,059 = $9,165DESIGNING A SUITABLE LOT SIZE-BASED QUANTITY DISCOUNT Design a suitable quantity discount that gets DO to order in lots of 9,165 units when its aims to minimize only its own total costs with EOQ as 6325. © Manufacturer needs to offer an incentive of at least $264 per year to DO in terms of decreased material cost if DO orders in lots of 9,165 units Appropriate quantity discount is to change $3 if DO orders in lots smaller than 9,165 units and discount the price to$2.9978 (=$3-264/120000) for orders of 9,165 or more QUANTITY DISCOUNTS WHEN FIRM HAS MARKET POW Demand curve = 360,000 - 60,000p Production cost = C,, = $2 per bottle Prof, = (p~C,)(360,000 60,000) Prof, = (Cy ~C,X(360,000 60,000 p) ptomaximize Prof, po3+B Profy=(Cy c,} 960000 2,003 %) =(C,—2)(180,000- 30,000)QUANTITY DISCOUNTS WHEN FIRM HAS MARKET POWER Cy = $4 per bottle, p = $5 per bottle Total market demand = 360,000 - 60,000p = 60,000 Prof = (5 - 4)(360,000 - 60,000 x 5) = $60,000 Profy= (4 - 2)(360,000 - 60,000 x 5) = $120,000 Now consider the coordination is made at price level in order to maximize the supply chain profit. = (~~ Cy)(360,000 - 60,000p) Coordinated retail price p =3+ Prof: = ($4 - $2) x 120,000 = $240,000 DOUBLE MARGINALIZATION NOLLVZNVNIDUYW J1ENnoG QUANTITY DISCOUNTS WHEN FIRM HAS MARKET POWER > Double marginalization \eads to loss of profit because the supply chain margins is divided between two stages. > A coordinated solution results into higher profit. > It is important to consider the pricing scheme that may help recover some of these profits even when each stage of the supply chain continues to act independently. » Following two pricing scheme can work well > Two-part tariff * Volume based quantity discount NOLIVZITYNIDUYW JTENorTWO-PART TARIFF © Manufacturer charges its entire profit as an up- front franchise fee /f Sells to the retailer at cost Retail pricing decision is based on maximizing its profits © Effectively maximizes the coordinated supply chain profit VOLUME-BASED QUANTITY DISCOUNTS © Design a volume-based discount scheme that gets the retailer to purchase and sell the quantity sold when the two stages coordinate their actionsLESSONS FROM DISCOUNTING SCHEMES © Quantity discounts play a role in supply chain coordination and improved supply chain profits ® Discount schemes that are optimal are volume based and not lot size based unless the manufacturer has large fixed costs associated with each lot © Even in the presence of large fixed costs for the manufacturer, a two-part tariff or volume-based discount, with the manufacturer passing on some of the fixed cost to the retailer, optimally coordinates the supply chain and maximizes profits LESSONS FROM DISCOUNTING SCHEMES Lot size-based discounts tend to raise the cycle inventory in the supply chain » Volume-based discounts are compatible with small lots that reduce cycle inventory ® Retailers will tend to increase the size of the lot toward the end of the evaluation period, the hockey stick phenomenon ‘th multiple retailers with different demand curves optimal discount continues to be volume based with the average price charged to the retailers decreasing as the rate of purchase increasesPRICE DISCRIMINATION TO MAXIMIZE SUPPLIER PROFITS Firm charges differential prices to maximize profits @ Setting a fixed price for all units does not maximize profits for the manufacturer © Manufacturer can obtain maximum profits by pricing each unit differently based on customers’ marginal evaluation at each quantity Quantity discounts are one mechanism for price discrimination because customers pay different prices based ‘on the quantity purchased SHORT-TERM DISCOUNTING; TRADE PROMOTIONS © Trade promotions are price discounts for a limited period of time © Key goals Induce retailers to use price discounts, displays, or advertising to spur} sales 2. Shift inventory from the manufacturer to the retailer and the customer 3. Defend a brand against competitionSHORT-TERM DISCOUNTING: TRADE PROMOTIONS © Impact on the behavior of the retailer and supply chain performance © Retailer has two primary options 1. Pass through some or all of the promotion to customers to spur sales 2. Pass through very little of the promotion to customers but purchase in greater quantity during the promotion period to exploit the temporary reduction in price (forward buy) FORWARD BUYING INVENTORY PROFILE NoFORWARD BUY @ Costs to be considered - material cost, holding cost, and order cost @ Three assumptions 1. The discount is offered once, with no future discounts 2. The retailer takes no action to influence customer demand 3. Analyze a period over which the demand is an integer multiple of O* FORWARD BUY © Optimal order quantity (Silver, Pyke and Petersen, 1998) = _@_, cot (C-d)h C-d * Retailers are often aware of the timing of the next promotion Forward buy=0"-0*IMPACT OF TRADE PROMOTIONS ON LOT SIZES Q' = 6,324 bottles, C = $3 per bottle = $0.15, D = 120,000, h = 0.2 Cycle inventory at DO = 0*/2 = 6,324/2 = 3,162 bottles Average flow time = 0*/2D = 6,324/(2D) = 0.3162 months of = iP _, 0" (C-ah_ C-d = 0.15% 120,000 (.00-0.15) x0.21 IMPACT OF TRADE PROMOTIONS ON LOT SIZES ® With trade promotions Cycle inventory at DO = 0/2 = 38,236/2 = 19,118 bottles Average flow time = 0"/2)) = 38,236/(20,000) = 1.9118 months Forward buy = 0" - Q* = 38,236 - 6,324 = 31,912 bottlesHOW MUCH OF A DISCOUNT SHOULD THE RETAILER PASS THROUGH? » Profits for the retailer ‘Prof = (300,000 - 60,000p)p - (300,000 - 60,000p)C', * Optimal price p= (300,000 + 60,000c;)/120,000 * Demand with no promotion Dx = 30,000 - 60,000p = 60,000 * Optimal price with discount p= (300,000 + 60,000 x 2.85)/120,000 = $3.925 * Demand with promotion Dx = 300,000 - 60,000p = 64,500 TRADE PROMOTIONS @ Trade promotions generally increase cycle inventory in a supply chain and hurt performance ® Counter measures = EDLP (every day low pricing) « Discount applies to items sold to customers (sell- through) not the quantity purchased by the retailer (sell-in) = Scan based promotionsMANAGING MULTI-ECHELON CYCLE INVENTO! © Multi-echelon supply chains have multiple stages with possibly many players at each stage @Lack of coordination in lot sizing decisions across the supply chain results in high costs and more cycle inventory than required ©The goal is to decrease total costs by coordinating orders across the supply chain MANAGING MULTIECHELON CYCLE INVENTORYINTEGER REPLENISHMENT POLICY ® Divide all parties within a stage into groups such that all parties within a group order from the same supplier and have the same reorder interval » Set reorder intervals across stages such that the receipt of a replenishment order at any stage is synchronized with the shipment of a replenishment order to at least one of its customers © For customers with a longer reorder interval than the supplier, make the customer’s reorder interval an integer multiple of the supplier's interval and synchronize replenishment at the two stages to facilitate cross-docking INTEGER REPLENISHMENT POLICY © For customers with a shorter reorder interval than the supplier, make the supplier’s reorder interval an integer multiple of the customer’s interval and synchronize replenishment at the two stages to facilitate cross-docking » The relative frequency of reordering depends on the setup cost, holding cost, and demand at different parties © These polices make the most sense for supply chains in which cycle inventories are large and demand is relatively predictableINTEGER REPLENISHMENT POLICY eo anes mew J esti. INTEGER REPLENISHMENT POLICY Ste Stage Stage Stage Stage v 2 2 + 5 Lecce ¥ |. wSUMMARY OF LEARNING OBJECTIVES 1. Balance the appropriate costs to choose the optimal lot size and cycle inventory in a supply chain 2. Understand the impact of quantity discounts on lot size and cycle inventory 3. Devise appropriate discounting schemes for a supply chain 4, Understand the impact of trade promotions ‘on lot size and cycle inventory