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Ko University Graduate School of Business

MBA Program

OPSM 501: Operations Management

Week 10:
Supply Chain contracts
Newsvendor
Zeynep Aksin
zaksin@ku.edu.tr
Hamptonshire Express

Anna has a degree from journalism & operations


research
She has started a daily newspaper in her hometown
She used a leased PC: lease cost $10 per day
A local printer prints newspapers at 0.20 per copy
Sales the next day between 6 am and 10 am
Newsstand rental $30 per day
Express sold to customers at $1 per copy
Copies not sold by 10 am are discarded
Anna estimates daily demand to be distributed
N(500,100)

2
Question 1

Optimal stocking quantity?


Profit at this stocking quantity?

3
Ordering Level and Profits in Vertically
Integrated Channel

h=1; Anna sells to market directly:


i* = 584; E[Profit] = $331.33; Fill rate 98%

4
Improving demand through effort

After 6 weeks of operation, Anna thinks she


can improve demand by adding a profile
section
Experiments indicate that demand is a function
of time she invests in preparing the section
She thinks D=500 +50 h

5
Question 2

How many hours should she invest daily in the


creation of the profile section? Assume the
opportunity cost of her time is $10 per hour.
Compare optimal profits to previous scenario

6
Optimal Level of Effort in Vertically
Integrated Channel

Demand potential increases by 50 h


Expected profit increases by 0.8*50 h

h h+1 0.8 * 50 * ( h 1 h )
01 40
12 16.56
i* = 684
23 12.71 E[Profit] =
34 10.71 371.33
7
45 9.44
Delegating sales to Ralph

Anna is really busy, so asks Ralph to take-over the


retailing portion of her job.
Ralph agrees to run the newsstand from 6 AM to 10 AM
and pay the daily rent of $30
He estimates demand the next day based on viewing a
copy of the paper the previous night at 10 PM
He buys the papers from Anna at $0.8 per copy
Ralph is responsible for unsold copies at the end of the
day

8
Question 3

Assuming h=4 try to determine the optimal stocking


quantity for Ralph?
Why is this quantity different than the one in Question 2?
Now vary h in spreadsheet 3c which calculates the
optimal newsboy quantity for the differentiated channel,
i.e. to maximize Ralphs profit.
How would changing the transfer price from the current
value of 0.8 impact Anns effort level and Ralphs
stocking decision? (Spreadsheet 3d)
Compare an integrated (centralized) firm to a
differentiated (decentralized) one.
9
Ordering Level and Profits in
Differentiated Channel

Case 1. h=4; Anna sells to market directly:


i* = 684; E[Profit] = $371.33; Fill rate 98%

Case 2. h=4; Anna sells thru Ralph:


i* = 516; E[Total Profit] = $322
Anna makes $260
Ralph makes $ 62
Fill rate 84%
Why?? 10
Effect of Transfer (Wholesale) Price in
Differentiated Channel

Breakdown of total profits (h=4)

400
350
300
250
ralph
$ 200
anna
150
100
50
0
3

9
0.

0.

0.

0.

0.

0.

0.

transfer price 11
Optimal Effort in Decentralized Channel

Optimal effort level for Anna is h=2 (and not 4).


h=2 h=4
Stocking quantity: $487 $516
Annas profit: $262 $260
Ralphs profit: $56 $ 62
Total profit: $318 $322
Fill rate: 83% 84%
Why?? 12
Inefficiencies in a Differentiated Channel

Supplier chooses w, retailer chooses i*


Retail ignores +ve effect of stocking one more
unit on supplier
Supplier ignores +ve effect of cutting
wholesale price/increasing effort on retailer
Supplier prices above marginal cost/exerts
low effort
Retailer stocks less
Supply chain profits shrink
13
Contracts

Specifies the parameters within which a buyer


places orders and a supplier fulfills them
Example parameters: quantity, price, time, quality
Double marginalization: buyer and seller make
decisions acting independently instead of acting
together; both of them make a margin on the
same sale gap between potential total supply
chain profits and actual supply chain profits
results
Buyback contracts can be offered that will
increase total supply chain profit
14
Returns policies

Rationale: set buyback price b so that


wb c s (retailer cost structure

r b r s = supply cost structure)

Supplier can use both w and b


Supplier is bundling insurance with the
good

15
Example

Breakdown of profits under a


buyback scheme

400
350
300
250 ralph
$ 200
150 anna
100
50
0
3

8
0
15

45

71

74

77
0.

0.

0.
0.

0.

0.

0.

0.

buyback price
16
Reasons for return policies

Supplier is less risk averse than


retailers
Supplier has a higher salvage value
Safeguarding the brand
Signalling information
Avoiding brand switching

17
Costs of Return Policies

Extra transportation and handling


Extra depreciation
Getting the return rate wrong
Retailer incentives

18
The case of books

Returns as in Hamptonshire Express


However publisher has no control of return
quantities
No control of inventory-shelf arrangements
No control over private-label
No control of retail price

Key difference: power has shifted from publisher


to retailer
19
Video sales

Hollywood: video rentals and sales


$20B business, and largest source of
revenue
Rentals slipping
Competition from direct services
Customer dissatisfaction (20% cannot rent
video they want on a typical trip)
Whats the problem? Bad forecasting?
Inefficient replenishment?
20
Revenue Sharing

Reduce wholesale price in return for a


share of revenues
Encourages retailers to stock more
$60 a tape
$3/rental rent each tape 20 times to break
even
$9 a tape, studio receives half revenue
$3/rental rent each tape 6 times to break
even
Retailer stocks more 21
Revenue sharing

When does it work?


marginal cost of increasing inventory low
administrative burden low
for price-sensitive products

22
The Impact of Revenue Sharing

Blockbuster Instituted the Go Home


Happy marketing initiative
Results
Store traffic went up
Market share 4th quarter 98 = 26%
Market share 2nd quarter 99 = 31%
Revenue in 2nd quarter 99: +17% from 98
Cash flow in 2nd quarter 99: +61% from 98

23
Customers,
Field demand
Sources: Regional Warehouses: centers
plants Warehouses: stocking sinks
vendors stocking points
ports points

Supply

Inventory &
warehousing
costs
Production/
purchase Transportation Transportation
costs costs costs
Inventory &
warehousing
costs
Supply Chain Management: the challenge

Global optimization
Conflicting Objectives
Complex network of facilities
System Variations over time
Managing uncertainty
Matching Supply and Demand
Demand is not the only source of uncertainty
The newsvendor is all around us

Newspaper
Apparel industry
The flu shot
Recall Marks & Spencer

Perfect forecast

Excess stock Excess demand

Expected demand Actual demand


Recall Zaraa Approach to Demand uncertainty

Excess stock and unmet demand are avoided by


stopping production when market saturates

Expected demand Actual demand


Small batches
Flu vaccine example

Each years flu vaccine is different: cant produce ahead


or keep from last year
Flu vaccine production requires growing strains: there is
a lead time
Factories have limited capacity
Demand is uncertain
Need to commit to production before flu season starts
Result: frequent shortage of vaccine or left overs at the
end of the season
The Newsvendor Model

Develop a Forecast: How did Anna come


up with N(500, 100) for example?

11-30
ONeills Hammer 3/2 wetsuit
Historical forecast performance at ONeill
7000

6000
.

5000
Actual demand

4000

3000

2000

1000

0
0 1000 2000 3000 4000 5000 6000 7000
Forecast

Forecasts and actual demand for surf wet-suits from the previous season
Empirical distribution of forecast accuracy
Product description Forecast Actual demand Error* A/F Ratio**
JR ZEN FL 3/2 90 140 -50 1.56
EPIC 5/3 W/HD 120 83 37 0.69
JR ZEN 3/2 140 143 -3 1.02
WMS ZEN-ZIP 4/3 170 163 7 0.96
HEATWAVE 3/2 170 212 -42 1.25
JR EPIC 3/2 180 175 5 0.97
WMS ZEN 3/2 180 195 -15 1.08
ZEN-ZIP 5/4/3 W/HOOD 270 317 -47 1.17
WMS EPIC 5/3 W/HD 320 369 -49 1.15 100%
EVO 3/2 380 587 -207 1.54 90%
JR EPIC 4/3 380 571 -191 1.50
WMS EPIC 2MM FULL 390 311 79 0.80 80%
HEATWAVE 4/3 430 274 156 0.64 70%

Probability
ZEN 4/3 430 239 191 0.56
EVO 4/3 440 623 -183 1.42 60%
ZEN FL 3/2 450 365 85 0.81 50%
HEAT 4/3 460 450 10 0.98
ZEN-ZIP 2MM FULL 470 116 354 0.25 40%
HEAT 3/2 500 635 -135 1.27 30%
WMS EPIC 3/2 610 830 -220 1.36
WMS ELITE 3/2 650 364 286 0.56 20%
ZEN-ZIP 3/2 660 788 -128 1.19 10%
ZEN 2MM S/S FULL 680 453 227 0.67
EPIC 2MM S/S FULL 740 607 133 0.82 0%
EPIC 4/3 1020 732 288 0.72 0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75
WMS EPIC 4/3 1060 1552 -492 1.46
JR HAMMER 3/2 1220 721 499 0.59 A/F ratio
HAMMER 3/2 1300 1696 -396 1.30
Empirical distribution function for the historical A/F ratios.
HAMMER S/S FULL 1490 1832 -342 1.23
EPIC 3/2 2190 3504 -1314 1.60
ZEN 3/2 3190 1195 1995 0.37
ZEN-ZIP 4/3 3810 3289 521 0.86
WMS HAMMER 3/2 FULL 6490 3673 2817 0.57
* Error = Forecast - Actual demand
** A/F Ratio = Actual demand divided by Forecast
Normal distribution tutorial

All normal distributions are characterized by two parameters, mean = m and standard
deviation = s
All normal distributions are related to the standard normal that has mean = 0 and
standard deviation = 1.
For example:
Let Q be the order quantity, and (m, s) the parameters of the normal demand
forecast.
Prob{demand is Q or lower} = Prob{the outcome of a standard normal is z or
lower}, where

Qm
z or Q m z s
s
(The above are two ways to write the same equation, the first allows you to
calculate z from Q and the second lets you calculate Q from z.)
Look up Prob{the outcome of a standard normal is z or lower} in the Standard
Normal Distribution Function Table.

11-34
Converting between Normal distributions
0.0180
Start with 0.0160 Center the
m= 100, 0.0140
distribution over 0
s= 25, 0.0120
by subtracting the
0.0100
Q = 125 0.0080 mean
0.0060
0.018
0.0040
0.016
0.0020
0.014
-
0 25 50 75 100 125 150 175 200 0.012
0.01
0.008
0.006
0.004
0.45
0.002
Qm
0.40

z
0
0.35

s
-100 -75 -50 -25 0 25 50 75 100
0.30

125 100 0.25

0.20
25 0.15 Rescale the x and y
1 0.10
axes by dividing by
0.05

0.00
the standard
-4 -3 -2 -1 0 1 2 3 4
deviation
11-35
Using historical A/F ratios to choose a
Normal distribution for the demand forecast
Start with an initial forecast generated from hunches, guesses, etc.
ONeills initial forecast for the Hammer 3/2 = 3200 units.
Evaluate the A/F ratios of the historical data:
Actual demand
A/F ratio
Forecast

Set the mean of the normal distribution to


Expected actual demand Expected A/F ratio Forecast

Set the standard deviation of the normal distribution to


Standard deviation of actual demand
Standard deviation of A/F ratios Forecast

11-36
ONeills Hammer 3/2 normal distribution
Product description
forecast
Forecast Actual demand Error A/F Ratio
JR ZEN FL 3/2 90 140 -50 1.5556
EPIC 5/3 W/HD 120 83 37 0.6917
JR ZEN 3/2 140 143 -3 1.0214
WMS ZEN-ZIP 4/3 170 156 14 0.9176


ZEN 3/2 3190 1195 1995 0.3746
ZEN-ZIP 4/3 3810 3289 521 0.8633
WMS HAMMER 3/2 FULL 6490 3673 2817 0.5659
Average 0.9975
Standard deviation 0.3690

Expected actual demand 0.9975 3200 3192


Standard deviation of actual demand 0.369 3200 1181

ONeill should choose a normal distribution with mean


3192 and standard deviation 1181 to represent demand
for the Hammer 3/2 during the Spring season.
11-37
Empirical vs normal demand distribution
1.00
0.90
0.80
0.70
.

0.60
Probability

0.50
0.40
0.30
0.20
0.10
0.00
0 1000 2000 3000 4000 5000 6000
Quantity
Empirical distribution function (diamonds) and normal distribution function with
mean 3192 and standard deviation 1181 (solid line)
11-38
Demand Scenarios for a Jacket

Demand Scenarios

30%
Probability

25%
20%
15%
10%
5%
0%

000 000 000 000 000 000


8 10 12 14 16 18
Sales
Costs

Production cost per unit (C): $80


Selling price per unit (S): $125
Salvage value per unit (V): $20
Fixed production cost (F): $100,000
Q is production quantity, D demand

Profit =
Revenue - Variable Cost - Fixed Cost + Salvage
Best Solution

Find order quantity that maximizes weighted


average profit.
Question: Will this quantity be less than, equal
to, or greater than average demand?
What to Make?

Question: Will this quantity be less than,


equal to, or greater than average demand?
Average demand is 13,100
Look at marginal cost Vs. marginal profit
if extra jacket sold, profit is 125-80 = 45
if not sold, cost is 80-20 = 60
So we will make less than average
Scenarios

Scenario One:
Suppose you make 12,000 jackets and demand ends
up being 13,000 jackets.
Profit = 125(12,000) - 80(12,000) - 100,000 = $440,000

Scenario Two:
Suppose you make 12,000 jackets and demand ends
up being 11,000 jackets.
Profit = 125(11,000) - 80(12,000) - 100,000 + 20(1000) = $
335,000
Scenarios and their probabilities
Demand
8000 10000 12000 14000 16000 18000 Average
Expected
11% 11% 28% 22% 18% 10% Profit
Profit
5,000 $125,000.00 $125,000.00 $125,000.00 $125,000.00 $125,000.00 $125,000.00 $125,000
5,500 $147,500.00 $147,500.00 $147,500.00 $147,500.00 $147,500.00 $147,500.00 $147,500
6,000 $170,000.00 $170,000.00 $170,000.00 $170,000.00 $170,000.00 $170,000.00 $170,000
6,500 $192,500.00 $192,500.00 $192,500.00 $192,500.00 $192,500.00 $192,500.00 $192,500
7,000 $215,000.00 $215,000.00 $215,000.00 $215,000.00 $215,000.00 $215,000.00 $215,000
Production quantity

7,500 $237,500.00 $237,500.00 $237,500.00 $237,500.00 $237,500.00 $237,500.00 $237,500


8,000 $260,000.00 $260,000.00 $260,000.00 $260,000.00 $260,000.00 $260,000.00 $260,000
8,500 $230,000.00 $282,500.00 $282,500.00 $282,500.00 $282,500.00 $282,500.00 $276,725
9,000 $200,000.00 $305,000.00 $305,000.00 $305,000.00 $305,000.00 $305,000.00 $293,450
9,500 $170,000.00 $327,500.00 $327,500.00 $327,500.00 $327,500.00 $327,500.00 $310,175
10,000 $140,000.00 $350,000.00 $350,000.00 $350,000.00 $350,000.00 $350,000.00 $326,900
10,500 $110,000.00 $320,000.00 $372,500.00 $372,500.00 $372,500.00 $372,500.00 $337,850
11,000 $80,000.00 $290,000.00 $395,000.00 $395,000.00 $395,000.00 $395,000.00 $348,800
11,500 $50,000.00 $260,000.00 $417,500.00 $417,500.00 $417,500.00 $417,500.00 $359,750
12,000 $20,000.00 $230,000.00 $440,000.00 $440,000.00 $440,000.00 $440,000.00 $370,700
12,500 -$10,000.00 $200,000.00 $410,000.00 $462,500.00 $462,500.00 $462,500.00 $366,950
13,000 -$40,000.00 $170,000.00 $380,000.00 $485,000.00 $485,000.00 $485,000.00 $363,200
13,500 -$70,000.00 $140,000.00 $350,000.00 $507,500.00 $507,500.00 $507,500.00 $359,450
14,000 -$100,000.00 $110,000.00 $320,000.00 $530,000.00 $530,000.00 $530,000.00 $355,700
14,500 -$130,000.00 $80,000.00 $290,000.00 $500,000.00 $552,500.00 $552,500.00 $340,400
15,000 -$160,000.00 $50,000.00 $260,000.00 $470,000.00 $575,000.00 $575,000.00 $325,100
15,500 -$190,000.00 $20,000.00 $230,000.00 $440,000.00 $597,500.00 $597,500.00 $309,800
16,000 -$220,000.00 -$10,000.00 $200,000.00 $410,000.00 $620,000.00 $620,000.00 $294,500
16,500 -$250,000.00 -$40,000.00 $170,000.00 $380,000.00 $590,000.00 $642,500.00 $269,75044
Expected Profit

Expected Profit

$400,000

$300,000
Profit

$200,000

$100,000

$0
8000 12000 16000 20000
Order Quantity
Expected Profit

Expected Profit

$400,000

$300,000
Profit

$200,000

$100,000

$0
8000 12000 16000 20000
Order Quantity
Expected Profit

Expected Profit

$400,000

$300,000
Profit

$200,000

$100,000

$0
8000 12000 16000 20000
Order Quantity
Important Observations
Tradeoff between ordering enough to meet demand and
ordering too much
Several quantities have the same average profit
Average profit does not tell the whole story

Question: 9000 and 16000 units


lead to about the same average
profit, so which do we prefer?
Probability of Outcomes

100%

80%
Probability

60% Q=9000
40% Q=16000

20%

0%
00

00

00
0

0
00

00

00

00

00
00

00

10

30

50
-3

-1

Cost
Key Insights from this Model

The optimal order quantity is not necessarily equal to average


forecast demand
The optimal quantity depends on the relationship between
marginal profit and marginal cost
Fixed cost has no impact on production quantity, only on
whether to produce or not
As order quantity increases, average profit first increases and
then decreases
As production quantity increases, risk increases. In other
words, the probability of large gains and of large losses
increases
Example

Mean demand=3.85 How much would you order?


Demand Probability
1 0.10
2 0.15
3 0.20
4 0.20
5 0.15
6 0.10
7 0.10
Total 1.00
Single Period Inventory Control

Economics of the Situation Known:


1. Demand > Stock --> Underage (under stocking) Cost
Cu = Cost of foregone profit, loss of goodwill
2. Demand < Stock --> Overage (over stocking) Cost
Co = Cost of excess inventory
Co = 10 and Cu = 20 How much would you order? More
than 3.85 or less than 3.85?
Incremental Analysis
Probability Probability Incremental
Incremental that incremental that incremental Expected
Demand Decision unit is not needed unit is needed Contribution
1 First 0.00 1.00 -10(0.00)+20(1.00)
=20

2 Second 0.10 0.90 -10(0.10)+20(0.90)


=17

3 Third 0.25 0.75 12.5


4 Fourth 0.45 0.55 6.5
5 Fifth 0.65 0.35 0.5
6 Sixth 0.80 0.20 -4
7 Seventh 0.90 0.10 -7

Co = 10 and Cu = 20
Generalization of the Incremental Analysis

Cash
Pr{Demand n} nth unit needed Flow
Cu
Stock n Chance
Point

nth unit not needed -Co


Decision
Point Pr{Demand n-1}

Base Case 0
Stock n-1
Generalization of the Incremental Analysis

Stock n Chance Expected Cash Flow


Cu Pr{Demand n} -Co Pr{Demand n-1}
Point

Decision
Point

Base Case
Stock n-1
Generalization of the Incremental Analysis

Order the nth unit if


Cu Pr{Demand n} - Co Pr{Demand n-1} >= 0
or
Cu (1-Pr{Demand n-1}) - Co Pr{Demand n-1} >= 0
or
Cu - Cu Pr{Demand n-1} -Co Pr{Demand n-1} >= 0
or
Pr{Demand n-1} =< Cu /(Co +Cu)

Then order n units, where n is the greatest number that satisfies the
above inequality.
Incremental Analysis

Incremental
Demand Decision Pr{Demand n-1}Order the unit?
1 First 0.00 YES

2 Second 0.10 YES


3 Third 0.25 YES
4 Fourth 0.45 YES
5 Fifth 0.65 YES
6 Sixth 0.80 NO -
7 Seventh 0.90 NO

Cu /(Co +Cu)=20/(10+20)=0.66

Order quantity n should satisfy:


P(Demand n-1) Cu /(Co +Cu)< P(Demand n)
Order Quantity for Single Period, Normal Demand

Find the z*: z value such that F(z)= Cu /(Co +Cu)

Optimal order quantity is: Qmzs *


The Standard Normal Distribution
z 0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09

Transform 0.0
0.1
0.5000
0.5398
0.5040
0.5438
0.5080
0.5478
0.5120
0.5517
0.5160
0.5557
0.5199
0.5596
0.5239
0.5636
0.5279
0.5675
0.5319
0.5714
0.5359
0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141
X = N(mean,s.d.) to 0.3 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879

z = N(0,1) 0.5
0.6
0.6915
0.7257
0.6950
0.7291
0.6985
0.7324
0.7019
0.7357
0.7054
0.7389
0.7088
0.7422
0.7123
0.7454
0.7157
0.7486
0.7190
0.7517
0.7224
0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
z = (X - mean) / s.d. 0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389

F(z) = Prob( N(0,1) < z)


1.0 0.8413 0.8438 0.8461 0.8485 0.8508 0.8531 0.8554 0.8577 0.8599 0.8621
1.1 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830
1.2 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015
1.3 0.9032 0.9049 0.9066 0.9082 0.9099 0.9115 0.9131 0.9147 0.9162 0.9177
1.4 0.9192 0.9207 0.9222 0.9236 0.9251 0.9265 0.9279 0.9292 0.9306 0.9319
1.5 0.9332 0.9345 0.9357 0.9370 0.9382 0.9394 0.9406 0.9418 0.9429 0.9441
1.6 0.9452 0.9463 0.9474 0.9484 0.9495 0.9505 0.9515 0.9525 0.9535 0.9545
1.7 0.9554 0.9564 0.9573 0.9582 0.9591 0.9599 0.9608 0.9616 0.9625 0.9633
1.8 0.9641 0.9649 0.9656 0.9664 0.9671 0.9678 0.9686 0.9693 0.9699 0.9706
1.9 0.9713 0.9719 0.9726 0.9732 0.9738 0.9744 0.9750 0.9756 0.9761 0.9767
2.0 0.9772 0.9778 0.9783 0.9788 0.9793 0.9798 0.9803 0.9808 0.9812 0.9817
2.1 0.9821 0.9826 0.9830 0.9834 0.9838 0.9842 0.9846 0.9850 0.9854 0.9857
F(z) 2.2 0.9861 0.9864 0.9868 0.9871 0.9875 0.9878 0.9881 0.9884 0.9887 0.9890
2.3 0.9893 0.9896 0.9898 0.9901 0.9904 0.9906 0.9909 0.9911 0.9913 0.9916
2.4 0.9918 0.9920 0.9922 0.9925 0.9927 0.9929 0.9931 0.9932 0.9934 0.9936
0 z 2.5 0.9938 0.9940 0.9941 0.9943 0.9945 0.9946 0.9948 0.9949 0.9951 0.9952
2.6 0.9953 0.9955 0.9956 0.9957 0.9959 0.9960 0.9961 0.9962 0.9963 0.9964
2.7 0.9965 0.9966 0.9967 0.9968 0.9969 0.9970 0.9971 0.9972 0.9973 0.9974

Transform back, knowing 2.8


2.9
0.9974
0.9981
0.9975
0.9982
0.9976
0.9982
0.9977
0.9983
0.9977
0.9984
0.9978
0.9984
0.9979
0.9985
0.9979
0.9985
0.9980
0.9986
0.9981
0.9986
z*: 3.0 0.9987 0.9987 0.9987 0.9988 0.9988 0.9989 0.9989 0.9989 0.9990 0.9990
3.1 0.9990 0.9991 0.9991 0.9991 0.9992 0.9992 0.9992 0.9992 0.9993 0.9993

X* = mean + z*s.d.
3.2 0.9993 0.9993 0.9994 0.9994 0.9994 0.9994 0.9994 0.9995 0.9995 0.9995
3.3 0.9995 0.9995 0.9995 0.9996 0.9996 0.9996 0.9996 0.9996 0.9996 0.9997
Example

z 0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09
If we want to 0.0 0.5000 0.5040 0.5080 0.5120 0.5160 0.5199 0.5239 0.5279 0.5319 0.5359

have cum. probability of


0.1 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141

95% 0.3
0.4
0.6179
0.6554
0.6217
0.6591
0.6255
0.6628
0.6293
0.6664
0.6331
0.6700
0.6368
0.6736
0.6406
0.6772
0.6443
0.6808
0.6480
0.6844
0.6517
0.6879
z=1.64 0.5
0.6
0.6915
0.7257
0.6950
0.7291
0.6985
0.7324
0.7019
0.7357
0.7054
0.7389
0.7088
0.7422
0.7123
0.7454
0.7157
0.7486
0.7190
0.7517
0.7224
0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
1.0 0.8413 0.8438 0.8461 0.8485 0.8508 0.8531 0.8554 0.8577 0.8599 0.8621
1.1 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830
1.2 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015
1.3 0.9032 0.9049 0.9066 0.9082 0.9099 0.9115 0.9131 0.9147 0.9162 0.9177

For demand: 1.4


1.5
0.9192
0.9332
0.9207
0.9345
0.9222
0.9357
0.9236
0.9370
0.9251
0.9382
0.9265
0.9394
0.9279
0.9406
0.9292
0.9418
0.9306
0.9429
0.9319
0.9441
Mean=20 1.6
1.7
0.9452
0.9554
0.9463
0.9564
0.9474
0.9573
0.9484
0.9582
0.9495
0.9591
0.9505
0.9599
0.9515
0.9608
0.9525
0.9616
0.9535
0.9625
0.9545
0.9633
std dev=10 1.8
1.9
0.9641
0.9713
0.9649
0.9719
0.9656
0.9726
0.9664
0.9732
0.9671
0.9738
0.9678
0.9744
0.9686
0.9750
0.9693
0.9756
0.9699
0.9761
0.9706
0.9767
2.0 0.9772 0.9778 0.9783 0.9788 0.9793 0.9798 0.9803 0.9808 0.9812 0.9817

Then:
2.1 0.9821 0.9826 0.9830 0.9834 0.9838 0.9842 0.9846 0.9850 0.9854 0.9857
2.2 0.9861 0.9864 0.9868 0.9871 0.9875 0.9878 0.9881 0.9884 0.9887 0.9890

Q=20 + 1.64*10=36.4 2.3


2.4
0.9893
0.9918
0.9896
0.9920
0.9898
0.9922
0.9901
0.9925
0.9904
0.9927
0.9906
0.9929
0.9909
0.9931
0.9911
0.9932
0.9913
0.9934
0.9916
0.9936
2.5 0.9938 0.9940 0.9941 0.9943 0.9945 0.9946 0.9948 0.9949 0.9951 0.9952
2.6 0.9953 0.9955 0.9956 0.9957 0.9959 0.9960 0.9961 0.9962 0.9963 0.9964
2.7 0.9965 0.9966 0.9967 0.9968 0.9969 0.9970 0.9971 0.9972 0.9973 0.9974
2.8 0.9974 0.9975 0.9976 0.9977 0.9977 0.9978 0.9979 0.9979 0.9980 0.9981
2.9 0.9981 0.9982 0.9982 0.9983 0.9984 0.9984 0.9985 0.9985 0.9986 0.9986
3.0 0.9987 0.9987 0.9987 0.9988 0.9988 0.9989 0.9989 0.9989 0.9990 0.9990
3.1 0.9990 0.9991 0.9991 0.9991 0.9992 0.9992 0.9992 0.9992 0.9993 0.9993
3.2 0.9993 0.9993 0.9994 0.9994 0.9994 0.9994 0.9994 0.9995 0.9995 0.9995
3.3 0.9995 0.9995 0.9995 0.9996 0.9996 0.9996 0.9996 0.9996 0.9996 0.9997
Example: Annas first stocking decision

Cu = 1-0.2=0.8 and Co = 0.2; P 0.8 / (0.8 + 0.2) = .8

Z.8 = .84 (from standard normal table or using NORMSINV() in


Excel)
therefore Anna needs 500 + .84(100) = 584 papers
Example: What about Ralphs first
stocking decision?
Anna sets h=4 D=N(500+50*2, 100)
Cu = 1-0.8=0.2 and Co = 0.8; P 0.2 / (0.8 +
0.2) = .2

Z0.2 = - Z0.8 =-0.84 (from standard normal table or


using NORMSINV() in Excel)
therefore Anna needs 600 - 0.84(100) = 516
papers
Example 2: Finding Cu and Co

A textile company in UK orders coats from China. They buy a coat from
250 and sell for 325. If they cannot sell a coat in winter, they sell it
at a discount price of 225. When the demand is more than what
they have in stock, they have an option of having emergency
delivery of coats from Ireland, at a price of 290.
The demand for winter has a normal distribution with mean 32,500
and std dev 6750.

How much should they order from China??


Example 2: Finding Cu and Co

A textile company in UK orders coats from China. They buy a coat from
250 and sell for 325. If they cannot sell a coat in winter, they sell it at
a discount price of 225. When the demand is more than what they
have in stock, they have an option of having emergency delivery of
coats from Ireland, at a price of 290.
The demand for winter has a normal distribution with mean 32,500 and
std dev 6750.

How much should they order from China??

Cu=75-35=40
Co=25
F(z)=40/(40+25)=40/65=0.61z=0.28
q=32500+0.28*6750=34390
Example 3: Single Period Inventory
Management Problem
Manufacturing cost=60TL,
Selling price=80TL, Discounted price (at the end of the season)=50TL
Market research gave the following probability distribution for demand.
Find the optimal q, expected number of units sold for this orders size, and
expected profit, for this order size.

Demand Probability P(D<=n-1) Cu=20 Co=10


500 0.10 0 P(D<=n-1)<=20/30=0.66
600 0.2 0.1
700 0.2 0.3
800 0.2 0.5 <=0.66 q=800
900 0.10 0.7
1000 0.10 0.8 For q=800:
1100 0.10 0.9 E(units sold)=710
E(profit)=13,300