Supply Chain Management

9 Planning Supply and Demand in a Supply Chain: Managing Predictable Variability

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Outline
Responding to predictable variability in a supply chain Managing supply Managing demand Implementing solutions to predictable variability in practice

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Responding to Predictable Variability in a Supply Chain

Predictable variability is change in demand that can be forecasted Can cause increased costs and decreased responsiveness in the supply chain A firm can handle predictable variability using two broad approaches:
Manage supply using capacity, inventory, subcontracting, and backlogs Manage demand using short-term price discounts and trade promotions
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Managing Supply
Managing capacity
Time flexibility from workforce Use of seasonal workforce Use of subcontracting Use of dual facilities dedicated and flexible Designing product flexibility into production processes

Managing inventory
Using common components across multiple products Building inventory of high demand or predictable demand products
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Inventory/Capacity Trade-off
Leveling capacity forces inventory to build up in anticipation of seasonal variation in demand Carrying low levels of inventory requires capacity to vary with seasonal variation in demand or enough capacity to cover peak demand during season

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Managing Demand
Promotion Pricing Timing of promotion and pricing changes is important
Pricing decisions based only on revenue may result in failure (marketing perspective). Operations have incentives based on cost Pricing and aggregate planning must be done jointly

Demand increases can result from a combination of three factors:

Market growth (increased sales, increased market size) Stealing share (increased sales, same market size) Forward buying (same sales, same market size)

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Ex: Red Tomato Tools

Green Thumb Gardens is a large retail chain that sells all products of Red Tomato Tools Demand is high in March and April Maximize SC profits and share it When to promote, in low or high season? Marketing dept. prefers high season, manufacturing dept prefers low season!

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Ex: Red Tomato Tools:

Given: Retail price=$40/unit Green Thumb I0=1000 units Red Tomato W0=80 employees 20 workdays exits in a month Each employee works for 8 hrs/day. Maximum 10 hrs/employee of overtime is allowed. No limits on subcontracting, inventories and stockouts. All stockouts are backlogged from the next month.
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Red Tomato Tools: No promotion

Month January February March April May June Demand Forecast 1,600 3,000 3,200 3,800 2,200 2,200

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Ex: Costs for Red Tomato Tools:

Item Materials cost/unit Inventory holding cost/unit/month Marginal cost of stockout/unit/month Hiring and training cost/worker Layoff cost/worker Labor hours required/unit Regular time cost/hour Over time cost/hour Marginal subcontracting cost/unit Cost $ $ $ $ $ $ $ $

10 2 5 300 500 4 4 6 30

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Ex: Aggregate Plan for Red Tomatoe and Green Thumb-No Promotion
Aggregate Plan Decision Variables

Ht
Period 0 1 2 3 4 5 6 # Hired 0 0 0 0 0 0 0

Lt
# Laid off 0 15 0 0 0 0 0

Wt
# Workforce 80 65 65 65 65 65 65

Ot

It

St
Stockout 0 0 0 0 267 0 0

Ct

Pt

Overtime Inventory 0 1,000 0 1,983 0 1,567 0 950 0 0 0 117 0 500

Subcontract Production 0 0 2,583 0 2,583 0 2,583 0 2,583 0 2,583 0 2,583

Cost = $ 422,275, Revenue = $640,000, Profit = $217,725 Average Flow Time= Av. Inv/Av. Sales=895/2667=0.34 months

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Demand Management
Pricing and aggregate planning must be done jointly Factors affecting discount timing
Product margin: Impact of higher margin ($40 instead of $31) Consumption: Changing fraction of increase coming from forward buy (100% increase in consumption instead of 10% increase) Forward buy

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Impact of promotion on demand

When a promotion is offered, demand increases can result from a combination of three factors:
Market growth (increased sales, increased market size) Promotion attracts people who could have afforded a lower model. Market size increases. Firms overall demand increases. Stealing share (increased sales, same market size) Substituting the firms product for a competitors product. Market size is not affected. Firms overall demand increases. Forward buying (same sales, same market size) Attract buyers who could have purchased a few months later. Market size is not affected. Firms overall demand does not increase. It is important to know the impact of promotion on demand to decide on the timing, why ??
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Impact of Promotion that Results in Forward Buying

Ex: Red Tomato Tools It is estimated that discounting from $40 to $39
Increases period demand by 10% due to increased consumption and substitution 20% of the the two following months demand is moved forward.

Decide on: Offer discount in January vs. April??

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Off-Peak (January) Discount from $40 to $39

Month January February March April May June Demand Forecast 3,000 2,400 2,560 3,800 2,200 2,200

Cost = $421,915, Revenue = $643,400, Profit = $221,485

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Ex: Aggregate Plan for Red Tomatoe and Green Thumb- Discount in January
Aggregate Plan Decision Variables

Ht
Period 0 1 2 3 4 5 6 # Hired 0 0 0 0 0 0 0

Lt
# Laid off 0 15 0 0 0 0 0

Wt
# Workforce 80 65 65 65 65 65 65

Ot

It

St
Stockout 0 0 0 0 320 0 0

Ct

Pt

Overtime Inventory 0 1,000 0 610 0 820 0 870 0 0 0 90 0 500

Subcontract Production 0 0 2,610 0 2,610 0 2,610 0 2,610 0 2,610 0 2,610

Cost = $421,915, Revenue = $643,400, Profit = $221,485

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Peak (April) Discount from $40 to $39

Month January February March April May June Demand Forecast 1,600 3,000 3,200 5,060 1,760 1,760

Cost = $438,857, Revenue = $650,140, Profit = $211,283

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Ex: Aggregate Plan for Red Tomatoe and Green Thumb- Discount in April
Aggregate Plan Decision Variables

Ht
Period 0 1 2 3 4 5 6 # Hired 0 0 0 0 0 0 0

Lt
# Laid off 0 14 0 0 0 0 0

Wt
# Workforce 80 66 66 66 66 66 66

Ot

It

St
Stockout 0 0 0 0 1,273 387 0

Ct

Pt

Overtime Inventory 0 1,000 0 2,047 0 1,693 0 1,140 0 0 0 0 0 500

Subcontract Production 0 0 2,647 0 2,647 0 2,647 0 2,647 0 2,647 0 2,647

Cost = $438,857, Revenue = $650,140, Profit = $211,283

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SC Coordination in Pricing and Aggregate Planning

This analysis is possible only because the retailer and the manufacturer collaborate during the planning phase! It is not appropriate for the SC to leave pricing decisions solely in the domain of retailers and aggregate planning solely in the domain of manufacturers. Forecasts, pricing and aggregate planning should be coordinated!

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Impact of Promotion that Results in Market Growth and Market Share Stealing
Ex: Red Tomato Tools It is estimated that discounting from $40 to $39 results in 100% increase in the period demand because of increased consumption and substitution 20% of the the two following months demand is moved forward. Decide on: Offer discount in January vs. April??

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January Discount: 100% Increase in Consumption, Sale Price = $40 ($39)

Month January February March April May June Demand Forecast 4,440 2,400 2,560 3,800 2,200 2,200

Off-peak discount: Cost = $456,750, Revenue = $699,560, Profit=$242,810

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Peak (April) Discount: 100% Increase in Consumption, Sale Price = $40 ($39)
Month January February March April May June Demand Forecast 1,600 3,000 3,200 8,480 1,760 1,760

Peak discount: Cost = $536,200, Revenue = $783,520, Profit = $247,320

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Performance Under Different Scenarios

Regular Price $40 $40 $40 $40 $40 $31 $31 $31 Promotion Price $40 $39 $39 $39 $39 $31 $30 $30 Promotion Period NA January April January April NA January April Percent increase in demand NA 10 % 10% 100% 100% NA 100% 100% Percent forward buy NA 20 % 20% 20% 20% NA 20% 20% Profit Average Inventory 895 523 938 208 1,492 895 208 1,492 $217,725 $221,485 $211,283 $242,810 $247,320 $73,725 $84,410 $69,120

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Factors Affecting Promotion Timing

Factor High forward buying High stealing share High growth of market High margin Low margin High holding cost Low flexibility Favored timing Low demand period High demand period High demand period High demand period Low demand period Low demand period Low demand period

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Key Results:
Faced with seasonal demand a firm should use a combination pricing (to manage demand) and production and inventory (to manage supply) to improve profitability. The precise use of each lever varies with the situation. SC profits are maximized only when forecasting and planning efforts are coordinated.
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Factors Influencing Discount Timing

Impact of discount on consumption Impact of discount on forward buy Product margin

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Implementing Solutions to Predictable Variability in Practice

Coordinate planning across enterprises in the supply chain Take predictable variability into account when making strategic decisions Preempt, do not just react to, predictable variability

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Summary of Learning Objectives

How can supply be managed to improve synchronization in the supply chain in the face of predictable variability? How can demand be managed to improve synchronization in the supply chain in the face of predictable variability? How can aggregate planning be used to maximize profitability when faced with predictable variability in the supply chain?

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