OMG 402 - Operations ManagementSpring 1997

CLASS 13:

Introduction to Logistics

Harry Groenevelt

March 1997 2

Agenda

• Introduction

• Service supply chains

• One-period decisions

• Supply chains in the apparel industry (Sport Obermeyer)

• Conclusions

3

Introduction: Some Vocabulary

• Logistics: procurement and distribution of material and information;

• Supply Chain Management: effectively integrating the production and distribution of products or services.

• Firms form competing supply chains which provide most value to customers at lowest cost.

4customers

Introduction: Generic Supply Chain

suppliers

manufacturer

distributors

retailers

Supplier Supplier Supplier

Plant

Warehouse

R R R

Warehouse

R R R

Warehouse

R R R

5

Introduction• Demand for Logistics Support is Growing. Why?

– new technologies for monitoring and management

– global sourcing, multi-site and international manufacturing

– demand for localization and customization

6

Introduction• Managers balance the cost of the supply chain and the

quality of products and services• Major components of cost:

– on-hand inventory– transportation and handling costs

• Measures of quality: – order fill rate (% of time product available when needed)– order lead time (time between order receipt and product delivery)– return rate (% of products returned because of defects, damage,

errors in order processing, etc.)

7

Q: What places us on Curve A or Curve B?Q: What is the function of the on-hand inventory?

Curve A

Curve B

Order Fill Rate0% 100%

On-handInventory(weeks ofsupply)

0

10

Introduction: Balancing Cost and Quality

March 1997 8

Supply Chain Management for Services

Information and Material

Flow

Inventory Capacity

• information indistinguishable from product

• delivery channel indistinguishable from product

• product changes significantly along each step of the chain (value-added)

• the customer can be a ‘co-producer’

• when inventory is impossible to hold, excess capacity and flexibility are crucial.

• in some services,high variability meanshigh inventory

• in others, inventory isimpossible to hold.

March 1997 9

Logistics for Services:

The Role of Inventory – Inventory costs can be significant (consider retail

sales, hospitals, aircraft maintenance)– High variability makes stocking decisions

difficult; poor decisions have a tremendous impact on customer service

Example: L.L. Bean plans production for a new teal turtleneck …

March 1997 10

• Uncertain demand and perishable product

• Order must be placed before demand is known• If not sold immediately, must liquidate• Decision: determine commitment quantity

One-Period Decisions

Pro

bab

ility

Den

sity

Demand for the turtleneck

March 1997 11

One-Period Decisions

Define:

• (random) demand for the turtleneck (d)

• commitment quantity (Q) (not the EOQ!)

Q: What factors influence the commitment quantity?

March 1997 12

One-period Decisions:

Commitment Quantity Trade-offs

• contribution margin or ‘gain’ (G)= opportunity cost of a lost sale (= $15 for teal turtleneck)

• liquidation cost or ‘loss’ (L)= cost of excess inventory (= $5 for teal turtleneck)

13

One-Period DecisionsDemand distribution

[assumed Normal with = 10,000, = 2,000]

0

0.00005

0.0001

0.00015

0.0002

0.00025

0 5000 10000 15000 20000

Demand for Teal Turtlenecks (d )

Pro

ba

bili

ty D

en

sit

y

14

One-Period Decisions

E[Profit] = E[Total Gain] – E[Liquidation Loss]

$0

$25,000

$50,000

$75,000

$100,000

$125,000

$150,000

0 5000 10000 15000 20000

Number of Teal Turtlenecks Ordered (Q )

Expected Liquidation Loss

Expected Profit

Expected Total Gain

15

One-Period Decisions

• Expected Total Gain rises as we increase the number ordered (Q). It reaches a limit at $150,000. Why?

• Expected Liquidation Loss rises as we increase the number ordered (Q). Is there any limit on the loss? Why?

Expected Profit is maximized between 11,000 and 12,000. Is there an analytical method for finding the optimal Q?

March 1997 16

outcome value probability

sold

not sold(liquidate)

Buy QthTurtleneck

What is expected value of Qth turtleneck?

One Period Decisions

• Decide how many to buy, given a forecast distribution for random variable d

March 1997 17

One Period Decisions

expected marginal gain from Qth item= (contribution margin) · Pr{Qth item is sold}= G · Pr{d Q} = G · [1–Pr{d < Q}]

expected marginal liquidation loss from Qth item= (liquidation cost) · Pr{Qth item is not sold}= L · Pr{d < Q}

buy Q as long as expected value > 0:G · [1– Pr{d < Q}] – L · Pr{d < Q} > 0

orPr{d < Q} < G/(L+G)

March 1997 18Note: relationship between uncertainty and inventory!

One Period Decisions: The Solution

Example: G = $15, L = $5, d ~ Normal(10000, 2000)

Pr{d < Q} = 15/(5 + 15) = 0.75

so

Q = 10,000 + 2,000 z0.75

= 10,000 + (2,000)(0.67) 11,350 turtlenecks

(z0.75 0.67 is the 75th percentile of the standard normal)

Buy Q so that Pr{d < Q} G/(L+G)

March 1997 19

Logistics for Services:

Don’t Take ‘G’ and ‘L’ for granted! – How to reduce the cost of a stock-out:

– How to reduce the cost of over-supply:

March 1997 20

Logistics for Services

Another example: USAir Flights from Boston to Rochester (scheduled flight time of 78 minutes)

0

5

10

15

20

25

65 75 85 95 105

115

125

135

Mor

e

Fre

qu

ency

histogram of flight duration (min.)July 1995

78 minutes (47th %-ile)

93 minutes (77th %-ile)

March 1997 21

Example from Air Transportation

USAir Flight 380 – benefits of adding minutes to schedule

– costs of adding minutes to schedule

22

Apparel Supply Chain

• “Fashions” limit product shelf life

• Traditionally long production lead times one production order once per season

• “Quick Response” – attempt to shorten production lead times

produce several times per season reduced liquidation loss and lost sales

23

Sport Obermeyer

Problem: – need to order 10,000 parkas now, and 10,000 later when

much more accurate demand forecasts will be available

– need to order at least 600 parkas of a particular style at a time to achieve production economies of scale (both now and with later orders)

– after second 10,000 parkas are ordered and the parkas are received, lost sales costs and liquidation losses are incurred

24

Sport Obermeyer

Observations:– Second round of orders should be used to “fine-tune”

the total number ordered for each style

– However, the second order for each style should be at least 600 parkas

– For the first round of orders, we want to maintain a high probability that at least 600 more parkas are required in the second round, so that we are not caught in a situation where we would like to buy 300 or so parkas in the second round

March 1997 25

Insights

• Performance of the supply chain affected by:– inventory

– capacity

– material/information flow

• Change one, others may change too• Trade-offs can be particularly acute in service

supply chains. Wisely designed information and material logistics dramatically reduce costs and improve service.