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ISC/SCLC SPRING 2006 MEETING

Hilton Marco Island


APRIL 29, 2006

How do you decide what to


produce when you dont know
what your customers will buy?
Marshall Fisher
UPS Professor, The Wharton
School
Cofounder and Chairman, 4R
Systems
2006 Marshall L.

Products differ

Cost of lost sale

Low

High

Risk of obsolescence

Low

High

Forecast accuracy

High

Low

Low

High

Long

Short

Product variety
Product life cycle

Functional
2005 Marshall L.

Innovative

And supply strategies differ

Factory focus
Inventory Strategy
Lead-time focus
Supplier selection
Product-design strategy

High utilization

Maintain buffer
capacity

High turns

Significant buffer stocks of


components and FGs

Low cost trumps


short lead-time

Aggressively
shorten lead-time

Low cost
Integral for max
performance at min cost

Physically efficient

2005 Marshall L.

Speed & flexibility


Modular to enable
postponed differentiation

Market
responsive

Respond quickly
to unpredictable
demand to
minimize
stockouts,
markdowns, and
obsolete inventory
2005 Marshall L.

Life cycle < 1 year


Gross Margin > 35%
High Product Variety

Functional Products

Innovative Products

Efficient
Supply Chain

Supply predictable
demand efficiently
at lowest cost

Life cycle > 2 years


Gross Margin < 35%
Low Product Variety

match

mismatch

Responsive
Supply Chain

Need to match supply strategy with product


type

mismatch

match

So as to minimize total of two types of costs

Raw
Materials

Component
Suppliers

Manufactur
er

Retailers

Consumer
s

Physical Production/Distribution Costs

Production Costs
Transportation Costs
Facility Utilization rates
Inventory carrying cost on pipeline and cycle stocks

Supply/Demand Mismatch Costs

Lost revenue and profit margin when supply is less than demand
Product and parts scrapped or sold at a loss when supply
exceeds demand
Inventory carrying cost on safety stocks
2005 Marshall L.

Dell reaps benefits from supply chain


innovation

Dell

S&P 500

Supply chain management is what its all


about Tom Meredith, Chief Financial Officer of
Dell
Source: Open manufacturing Online, July 28, 1998
2005 Marshall L.

P & G has grown earnings faster than sales by


cutting supply chain costs
P&G Net Sales and Net Earnings
1990-98
40000

10000

35000

9000

25000

6000

20000

5000

15000

4000
3000

10000

2000

trendlin
e

2005 Marshall L.

1998

1997

1996

1995

1994

1993

1990

1000

1992

5000

1991

Net Sales ($M)

7000

Source: Company 10K reports


Note: 1993-94 accounting change makes series
discontinuous.

Net Earnings ($M)

8000

30000

During 9498
Net Sales
grew 22.3%
Net Earnings
grew 71%

A page from Sport


Obermeyers product catalog

2005 Marshall L.

Next years
catalog

2005 Marshall L.

Obermeyers styles are fashion-forward


and change every year

2005 Marshall L.

The Obermeyer supply chain stretches


from Asia to Aspen

Factories in
China

DC in
Denver

800 Ski
Retailers

Obermeyers planning calendar is driven by


when it snows

2005 Marshall L.

Which parka family sold best?

Black Voodoo sold


4000
2005 Marshall L.

Sold 4

Initial forecasts are highly inaccurate


Black Voodoo

2005 Marshall L.

Measuring the cost of over and under


supply

Orders
Production
Lost sales
Full price = $200

4000
4
2000
2000
2000
Excess
1996
Markdown price = 130 Variable cost = 150

Lost sales cost $50 x 2000 =


$100,000

Excess cost $20 x 1996 = $39,920

Initial forecasts are highly inaccurate

but improve
dramatically with
just a little sales
data
2005 Marshall L.

Early write
Bring 25 (out of 800) largest retailers to Aspen in
February. Accounts for 20% of sales.
Put them up at the Ritz Carlton
They ski with Klaus Obermeyer, an industry icon
They get an advance preview of the line
They order early

Lead time reduction


Asia
Fabric
Producer

Fabric
Dyer

undyed greige
goods

Cut/Sew
Factory

Denver
Warehouse

Retailer

Sport Obermeyer

Consumer

Fabric dyer lead time of several months was a problem for Obermeyer
Dyer has long lead time on greige goods and needed to keep their
capacity utilized year round but can change colors overnight
Obermeyer can predict total annual sales and sales of basic colors,
but cant predict fashion colors

Solution
Offer dyer one year commitment on greige goods and capacity
Dye basic colors early in year and fashion colors late in
season on few days notice

2005 Marshall L.

Revised planning calendar

2005 Marshall L.

Sample buying committee projections


Which product is more predictable?
Laura

Tom

Kenny

Wally

Pandora
Parka

1200

1150

1250

1300

1100

1200

1200

65

Entice
Shell

1500

700

1200

300

2075

1425

1200

572

2005 Marshall L.

Wendy Averag
e

Std.
Dev.

Caroly
n

The committee process allowed us to forecast


forecast accuracy
1400

High
Error

1200

Average
Error =
155 units

1000

Forecast
Error

Average
Error =
252 units

800

600

400

Low
Error

200

0
0

110

High Agreement

220

330

Low Agreement

Standard Deviation of the Individual


Forecasts of a Six Person Committee

2005 Marshall L.

Obermeyer Committee Forecasts


STYLE COLOR
#
#

Wholesale
Price
LK

CO

SS

CB

JD

WS

WRO TT

GW

AM

COMM COMM
AVE
STD DEV

AS
6220

77.5
64
45
78
9
TOTAL:

6221

479
650
50
180
1359

700
200
300
300
1500

500
500
200
200
1400

350
600
350
500
1800

700
200
300
400
1600

700
200
750
450
2100
930
1450
450
1529
500
350

400
475
200
560
100
475
100
390
800 1900

600 414 300


800 614 300
300 895 300
290 876 400
1990 2799 1300

600
340
840
340
600
510
360
510
2400 1700

481
500
373
361
1715

125
233
253
217
581

500
600
400
400
400
500
300
100
385
400
400
320
1600 1500 1605

275 465
575 542
400 310
150 233
1400 1550

200
300
175
175
850

420
300
516
375
432
600
72
225
1440 1500

421
441
335
288
1485

152
128
138
137
249

700
200
500
600
2000

400 1100
350
400
400
250
500
200
350
500
300
150
1800 2000 1100

550 771 400


375 135 100
725 539 500
150 275 300
1800 1720 1300

400
600
672
300
400
800
200
300
1672 2000

597
303
526
323
1749

232
168
189
150
324

800
600
600
2100
400
300

700
300
740
1300 1000 1310
500
300
150
1400 2100 1225
400
400
320
300
100
385

1015 1415
1750 1291
150 275
1425 1650
150 233
400 310

760 1310
2028 1015
200
300
1420 1240
72
225
432
600

887
1244
323
1499
288
335

316
440
150
375
137
138

94.5
64
45
78
76
TOTAL:

6222

9.5
64
45
9
49
TOTAL:

Color forecasts 9
45
49
64
76
78

2005 Marshall L.

900
700
300
900
175
175

Historical Distribution of Forecast Errors


Follows the Normal Bell-Shaped Curve

2005 Marshall L.

The Normal Distribution Accurately


Models Demand Uncertainty at
Obermeyer

Pandora Parka

15%

33%

33%

2%

2%
740

15%

970

1200

1430

1660

Probability Distribution for Sales of Pandora


Mean = 1200 Standard Deviation = 230
2005 Marshall L.

Cost of Under and Over Production


Pandora Parka
Wholesale Price
Less
Supplier charges
Sales Commission
Inventory carrying/Delivery
Profit Margin
Markdown Price
Less
Supplier charges
Inventory carrying/delivery
Loss

2005 Marshall L.

$ 200
100
30
25
_____
$ 45

Cost of Under Productio

$ 120
100
35
_____
($15)

Cost of Over Production

Production
Decision if we can
only buy once
Probability = .25

Pandora Parka

1200 1430

Probabilistic Break Even Analysis


Produce to the point where
Probability we sell x Gain if we sell = Probability we dont sell x Loss if we
dont sell
.25 x 45 = .75 x 15

Gain if we sell
2005 Marshall L.

Loss if we dont sell

Accurate Response Optimization Model

Demand Distributions
Cost of Stockouts & Excess Inventory
Production Capacity and Minimum Constraints
Minimize Expected Cost
of Stockouts
& Excess Inventory

Risk Adjusted Production Commitments by Style/Color


Can be used as Simulation Model to measure the impact
of better information or increased supply chain flexibility

2005 Marshall L.

Desk top tool run by user

Factories in
China

DC in
Denver
Order 50%
in April

Order 50%
in
November

Forecasts

Product
Sketches

Forecast
Committee

800 Ski
Retailers
Retailers
order in
Feb & April

Results of a parallel test show profit increase


equal to 1.8% of sales
Legacy
Process
Decisions

Optimization
Model
Decisions
Total Production (Units)
Demand
103,,831
Over-Production (Units)
Under-Production (Units)
7,493

124,805

121,432

103,831
22,036

25,094
792

Over-Production Cost (% of Sales)


1.74%
Under-Production Cost (% of Sales)
Total Cost (% of Sales)

2005 Marshall L.

1.30%
0.18%
1.48%

1.56%
3.30%

Retailers Loved the New Program!

2005 Marshall L.

Obermeyer process at World, a major Japanese


retailer

2005 Marshall L.

Right Buy: Commercial


Implementation of the Obermeyer
concept

Elements of the Obermeyer process


Which of these would be useful in your
company?
Early orders are highly predictive
Early write -> bring 25 largest retailers to Aspen to
order early
Cut lead times on expensive, long lead time component
dyed fabric
Use committee forecast process to forecast forecast
errors
Risk based production sequencing
Replace point forecast by probability distribution
Make predictable volume early.
Set production volumes based on likely forecast
accuracy and cost of over and under production.

How to think about supply chain improvement


Product
Availability

How does product availability


drive revenue?

Inventory

Accurate
Forecasts
Track & improve the accuracy
of forecasts that drive
decisions e.g. parts lead time
demand
2005 Marshall L.

Responsive
Supply Chain

Optimize cost of
lost margin,
carrying and
obsolescence

Create a framework for


inventory efficiency e.g.
common parts, short lead
times, efficient small lot
production