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9Planning Supply and Demandin a Supply Chain: Managing

Predictable Variability

Supply Chain Management

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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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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.

Ex: Red Tomato Tools:

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Red Tomato Tools: No promotion

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

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Ex: Costs for Red Tomato Tools:

Item CostMaterials cost/unit 10$ Inventory holding cost/unit/month 2$ Marginal cost of stockout/unit/month 5$ Hiring and training cost/worker 300$ Layoff cost/worker 500$ Labor hours required/unit 4Regular time cost/hour 4$ Over time cost/hour 6$ Marginal subcontracting cost/unit 30$

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

Aggregate Plan Decision Variables

Ht Lt Wt Ot It St Ct PtPeriod # Hired # Laid off # Workforce Overtime Inventory Stockout Subcontract Production

0 0 0 80 0 1,000 0 01 0 15 65 0 1,983 0 0 2,5832 0 0 65 0 1,567 0 0 2,5833 0 0 65 0 950 0 0 2,5834 0 0 65 0 0 267 0 2,5835 0 0 65 0 117 0 0 2,5836 0 0 65 0 500 0 0 2,583

Cost = $ 422,275, Revenue = $640,000, Profit = $217,725Average 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. Firm’s overall demand increases.

– Stealing share (increased sales, same market size)

Substituting the firm’s product for a competitor’s product. Market size is not affected. Firm’s 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. Firm’s 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 Demand ForecastJanuary 3,000February 2,400

March 2,560April 3,800May 2,200June 2,200

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

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Aggregate Plan Decision Variables

Ht Lt Wt Ot It St Ct PtPeriod # Hired # Laid off # Workforce Overtime Inventory Stockout Subcontract Production

0 0 0 80 0 1,000 0 01 0 15 65 0 610 0 0 2,6102 0 0 65 0 820 0 0 2,6103 0 0 65 0 870 0 0 2,6104 0 0 65 0 0 320 0 2,6105 0 0 65 0 90 0 0 2,6106 0 0 65 0 500 0 0 2,610

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

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

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Peak (April) Discountfrom $40 to $39

Month Demand ForecastJanuary 1,600February 3,000

March 3,200April 5,060May 1,760June 1,760

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

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Aggregate Plan Decision Variables

Ht Lt W t Ot It St Ct PtPeriod # Hired # Laid off # Workforce Overtime Inventory Stockout Subcontract Production

0 0 0 80 0 1,000 0 01 0 14 66 0 2,047 0 0 2,6472 0 0 66 0 1,693 0 0 2,6473 0 0 66 0 1,140 0 0 2,6474 0 0 66 0 0 1,273 0 2,6475 0 0 66 0 0 387 0 2,6476 0 0 66 0 500 0 0 2,647

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

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 Demand ForecastJanuary 4,440February 2,400

March 2,560April 3,800May 2,200June 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 Demand ForecastJanuary 1,600February 3,000

March 3,200April 8,480May 1,760June 1,760

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

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Performance UnderDifferent Scenarios

Regular Price

Promotion Price

Promotion Period

Percent increase in demand

Percent forward buy

Profit Average Inventory

$40 $40 NA NA NA $217,725 895 $40 $39 January 10 % 20 % $221,485 523 $40 $39 April 10% 20% $211,283 938 $40 $39 January 100% 20% $242,810 208 $40 $39 April 100% 20% $247,320 1,492 $31 $31 NA NA NA $73,725 895 $31 $30 January 100% 20% $84,410 208 $31 $30 April 100% 20% $69,120 1,492

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Factors AffectingPromotion Timing

Factor Favored timingHigh forward buying Low demand periodHigh stealing share High demand periodHigh growth of market High demand periodHigh margin High demand periodLow margin Low demand periodHigh holding cost Low demand periodLow flexibility 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?