OPSM 901: Operations Management

1. Koç University Graduate School of Business EMBA Program OPSM 901: Operations Management Session 8: Supply Chain Management Partnerships, supply contracts Zeynep Aksin zaksin@ku.edu.tr

2. Today’s plan • Vestel B group work • Vestel case discussion • Strategic partnerships • Supply chain contracts

4. Ankara 3 3 Erzurum Manisa 5 3 Adana 3*$10/dis. + 11*$6/dis. = $96 (1 TV + 4 Ref) (2 TV + 2 Ref) (4 TV + 1 Ref) Large Truck Small Truck 1 Small Truck 2

5. Strategic Partnerships in Supply Chains • 3PL • Retailer-supplier partnerships • Quick response • Continuous replenishment • Advanced continous replenishment • VMI • Distributor integration • Transshipment • Technical expertise sharing

6. Example: 3PL • Focus on core strengths • Provides technological flexibility • Provides other flexibilities: geographic locations, regional warehousing, etc. • Disadvantages: loss of control, 3PL interacting with customers • A form of outsourcing

7. 3PL Success factors • Know your own costs • Measurability-data availability • Activity based costing • Customer orientation of the 3PL • Specialization of the 3PL • import-export • Small package • Warehousing • Ship logistics • Etc. • Asset-owning versus non-asset-owning

8. 3PL Implementation Issues • Effective communication • Performance measures • Detailed contracts/agreements • Performance follow-up procedures

9. Retailer-supplier partnerships • Quick Response: Vendors receive POS data from retailers, and use this information to synchronize production and inventory activities at the supplier. In this strategy, the retailer still prepares individual orders, but the POS data is used by the supplier to improve forecasting and scheduling.

10. Retailer-supplier partnerships • Continuous Replenishment: Vendors receive POS data and use it to prepare shipments at previously agreed upon intervals to maintain agreed to levels of inventory. • Wal-Mart • Advanced Continuous Replenishment: Suppliers may gradually decrease inventory levels at the retailer’s store or distribution center as long as service levels are met. Inventory levels are thus continuously improved in a structured way.

11. Retailer-supplier partnerships • Vendor Managed Inventory (VMI):JITD • VMI Projects at Dillard Department Stores, J.C. Penney, and Wal-Mart have shown sales increases of 20 to 25 percent, and 30 percent inventory turnover improvements.

12. Main Characteristics of RS-SPs

13. Distributor integration: transshipment • “shipment of items between different facilities at the same level in the supply chain to meet some immediate need” • Between retailers • Between separately owned distributors: requires distributor integration, typically orchestrated by the manufacturer • Information system to enable inventory visibility • Incentives both ways so that distributors are willing to share their inventory

14. Requirements for Effective SP • Advanced information systems • Top management commitment • Mutual trust

15. On Trust.. • Can only “trust” people/firms to do what’s in their best interest Align incentives/procedures so that agent responses lead to revenue growth/cost reduction for all Have mechanism to share gains

16. SnowTime Sporting Goods (Source: Simchi Levi) • Fashion items have short life cycles, high variety of competitors • SnowTime Sporting Goods • New designs are completed • One production opportunity • Based on past sales, knowledge of the industry, and economic conditions, the marketing department has a probabilistic forecast • The forecast averages about 13,000, but there is a chance that demand will be greater or less than this.

17. SnowTime Demand Scenarios

18. SnowTime 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

19. SnowTime Best Solution • Find order quantity that maximizes weighted average profit. • Question: Will this quantity be less than, equal to, or greater than average demand?

20. 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

21. SnowTime 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

22. SnowTime Expected Profit

23. SnowTime Expected Profit

24. SnowTime Expected Profit

25. SnowTime: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?

26. Probability of Outcomes

27. 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 • 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

28. Fixed Production Cost =$100,000 Variable Production Cost=$35 Selling Price=$125 Salvage Value=$20 Manufacturer DC Manufacturer Retail DC Stores Supply Contracts Wholesale Price =$80

29. Demand Scenarios

30. Distributor Expected Profit

31. Distributor Expected Profit

32. Supply Contracts (cont.) • Distributor optimal order quantity is 12,000 units • Distributor expected profit is $470,000 • Manufacturer profit is $440,000 • Supply Chain Profit is $910,000 • Is there anything that the distributor and manufacturer can do to increase the profit of both?

33. Fixed Production Cost =$100,000 Variable Production Cost=$35 Selling Price=$125 Salvage Value=$20 Manufacturer DC Manufacturer Retail DC Stores Supply Contracts Wholesale Price =$80

34. Retailer Profit (Buy Back=$55)

35. Retailer Profit (Buy Back=$55) $513,800

36. Manufacturer Profit (Buy Back=$55)

37. Manufacturer Profit (Buy Back=$55) $471,900

38. Fixed Production Cost =$100,000 Variable Production Cost=$35 Selling Price=$125 Salvage Value=$20 Manufacturer DC Manufacturer Retail DC Stores Supply Contracts Wholesale Price =$80

39. Retailer Profit (Wholesale Price $70, RS 15%)

40. Retailer Profit (Wholesale Price $70, RS 15%) $504,325

41. Manufacturer Profit (Wholesale Price $70, RS 15%)

42. Manufacturer Profit (Wholesale Price $70, RS 15%) $481,375

43. Supply Contracts

44. Fixed Production Cost =$100,000 Variable Production Cost=$35 Selling Price=$125 Salvage Value=$20 Manufacturer DC Manufacturer Retail DC Stores Supply Contracts Wholesale Price =$80

45. Supply Chain Profit

46. Supply Chain Profit $1,014,500

47. Supply Contracts

48. Supply Contracts: Key Insights • Effective supply contracts allow supply chain partners to replace sequential optimization by global optimization • Buy Back and Revenue Sharing contracts achieve this objective through risk sharing

49. Inefficiencies in a Differentiated Channel: The publishing industry as an example • Supplier chooses wholesale price, retailer chooses quantity to stock • Retail ignores +ve effect of stocking one more unit on supplier • Supplier ignores +ve effect of cutting wholesale price on retailer • Supplier prices above marginal cost • Retailer stocks less • Supply chain profits shrink

50. Contract based solution: buyback or returns contracts • Why does it work? • Supplier is less risk averse than retailers • Supplier has a higher salvage value • Desire to safeguard the brand • Desire to avoid brand switching • Signalling information