Homework 9

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Supply Chain Management: Strategy, Planning, and Operation

Seventh Edition

Chapter 9

Sales and Operations Planning in a Supply Chain

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Learning Objectives

9.1 Manage supply and demand to improve synchronization in a supply chain in the face of predictable variability.

9.2 Use sales and operations planning to maximize profitability when faced with predictable variability in a supply chain.

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

Two broad options

Manage supply using capacity, inventory, subcontracting, and backlogs

Manage demand using short-term price discounts and promotions

Managing Supply (1 of 2)

Managing capacity

Time flexibility from workforce

Use of seasonal workforce

Use of dual facilities – specialized and flexible

Use of subcontracting

Designing product flexibility into production processes

Managing Supply (2 of 2)

Managing inventory

Using common components across multiple products

Build inventory of high-demand or predictable-demand products

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

Notes:

Managing Demand (1 of 4)

With promotion, three factors lead to increased demand

Market growth

Stealing share

Forward buying

Factors influencing timing of a promotion

Impact of promotion on demand

Cost of holding inventory

Cost of changing the level of capacity

Product margins

Managing Demand (2 of 4)

Table 9-1 Summary of Impact on Promotion Timing

Factor	Impact on Timing of Promotion/ Forward Buy
High forward buying	Favors promotion during low-demand periods
High ability steal market share	Favors promotion during peak-demand periods
High ability to increase overall market	Favors promotion during peak-demand periods
High margin	Favors promotion during peak-demand periods
Low margin	Favors promotion during low-demand periods
High manufacturer holding costs	Favors promotion during low-demand periods
High costs of changing capacity	Favors promotion during low-demand periods
High retailer holding costs	Decreases forward buying by retailer
High promotion elasticity of consumer	Decreases forward buying by retailer

Summary of Learning Objective 1

Companies can maximize profits by managing supply and demand to improve synchronization in a supply chain in the face of predictable variability. Supply can be managed using capacity or inventory. Companies can reduce the capacity required through the use of workforce flexibility, subcontracting, dual facilities, and product flexibility. Companies can reduce the inventory required by emphasizing common parts and building and holding products with predictable demand ahead of time. Demand can be managed using pricing and promotion decisions because the timing of promotions has a tremendous impact on demand. Therefore, using pricing to shape demand in concert with supply planning can help improve supply chain profits.

Sales and Operations Planning at Red Tomato

Table 9-2 Costs for Red Tomato and Green Thumb

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

Managing Demand (3 of 4)

Figure 9-1 Base Case Aggregate Plan for Red Tomato and Green Thumb

Managing Demand (4 of 4)

Total cost over planning horizon = $422,660

Revenue over planning horizon = $640,000

Profit over planning horizon = $217,340

When to Promote

Is it more effective to promote during the peak period of off-peak?

Analyze the impact of a promotion on demand and the resulting optimal aggregate plan

Promotion in January (1 of 2)

Figure 9-2 Optimal Aggregate Plan When Discounting Price in January to $39

Promotion in January (2 of 2)

Total cost over planning horizon = $422,080

Revenue over planning horizon = $643,400

Profit over planning horizon = $221,320

Lower seasonal inventory

A somewhat lower total cost

A higher total profit

Promotion in April (1 of 2)

Figure 9-3 Optimal Aggregate Plan When Discounting Price in April to $39

Promotion in April (2 of 2)

Total cost over planning horizon = $438,920

Revenue over planning horizon = $650,140

Profit over planning horizon = $211,220

Higher seasonal inventory

A somewhat higher total cost

A slightly smaller total profit

Discount Leads to Large Increase in Consumption (1 of 4)

Promotion in January

Figure 9-4 Optimal Aggregate Plan When Discounting Price in January to $39 with Large Increase in Demand

Discount Leads to Large Increase in Consumption (2 of 4)

Total cost over planning horizon = $456,880

Revenue over planning horizon = $699,560

Profit over planning horizon = $242,680

Higher total profit than base case

Discount Leads to Large Increase in Consumption (3 of 4)

Promotion in April

Figure 9-5 Optimal Aggregate Plan When Discounting Price in April to $39 with Large Increase in Demand

Discount Leads to Large Increase in Consumption (4 of 4)

Total cost over planning horizon = $536,200

Revenue over planning horizon = $783,520

Profit over planning horizon = $247,320

Much higher level of seasonal inventory

Uses more stockouts and subcontracting

Revenues increase

Overall profits higher

Supply Chain Performance

Table 9-3 Supply Chain Performance Under Different Scenarios

Regular Price	Promotion Price	Promotion Period	Percentage of Increase in Demand	Percentage of Forward Buy	Profit	Average Inventory
$40	$40	NA	NA	NA	$217,340	875
$40	$39	January	10%	20%	$221,320	515
$40	$39	April	10%	20%	$211,220	932
$40	$39	January	100%	20%	$242,680	232
$40	$39	April	100%	20%	$247,320	1,492
$31	$31	NA	NA	NA	$73,340	875
$31	$30	January	100%	20%	$84,280	232
$31	$30	April	100%	20%	$69,120	1,492

Conclusions on Promotion (1 of 3)

Average inventory increases if a promotion is run during the peak period and decreases if the promotion is run during the off-peak period

Promoting during a peak-demand month may decrease overall profitability if there is a small increase in consumption and a significant fraction of the demand increase results from a forward buy

Conclusions on Promotion (2 of 3)

As the consumption increase from discounting grows and forward buying becomes a smaller fraction of the demand increase from a promotion, it is more profitable to promote during the peak period

As the product margin declines, promoting during the peak-demand period becomes less profitable

Conclusions on Promotion (3 of 3)

When faced with seasonal demand, use combination of pricing and production and inventory to improve profitability

Entire supply chain must work toward one goal of maximizing profitability

High-level support within an organization is necessary

Early warning alerts should be built into the S & O P process

Summary of Learning Objective 2

To handle predictable variability in a profit-maximizing manner, supply chains must coordinate the management of both supply and demand. This requires coordinated planning across all stages of the supply chain to select pricing and promotion plans and aggregate plans that maximize supply chain profit. Sales and operations planning allows a supply chain to coordinate the planning of pricing and promotions along with the planning of production to maximize profits. To achieve coordination in practice, it is important that the S & O P process be owned by a senior leader within the supply chain.

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supply chain profits. Determining how these profits will be allocated to different members of the supply chain is key to successful collaboration.

Red Tomato and Green Thumb are exploring how the timing of retail promotions affects profitability. Are they in a better position if they offer the price promotion during the peak period of demand or during a low-demand period? Green Thumb’s vice president of sales favors a pro- motion during the peak period because this increases revenue by the largest amount. In contrast, Red Tomato’s vice president of manufacturing is against such a move because it increases manu-

The Base Case

We start by considering the base case discussed in Chapter 8. Each tool has a retail price of $40. Red Tomato ships assembled tools to Green Thumb, where all inventory is held. Green Thumb has a starting inventory in January of 1,000 tools. At the beginning of January, Red Tomato has a workforce of 80 employees at its manufacturing facility in Mexico. There are 20 working days in each month, and Red Tomato workers earn the equivalent of $4 per hour. Each employee works eight hours on normal time and the rest on overtime. Because the Red Tomato operation consists mostly of hand assembly, the capacity of the production operation is determined primarily by the total labor hours worked (i.e., it is not limited by machine capacity). No employee works more than 10 hours of overtime per month. The various costs are shown in Table 9-2.

There are no limits on subcontracting, inventories, and stockouts. All stockouts are back- logged and supplied from the following month’s production. Inventory costs are incurred on the ending inventory in each month. The companies’ goal is to obtain the optimal aggregate plan that leaves at least 500 units of inventory at the end of June (i.e., no stockouts at the end of June and

TABLE 9-2 Costs for Red Tomato and Green Thumb Item Cost

Material cost $10/unit

Inventory holding cost $2/unit/month

Marginal cost of a stockout $5/unit/month

Hiring and training costs $300/worker

Layoff cost $500/worker

Labor hours required 4/unit

Regular-time cost $4/hour

Overtime cost $6/hour

Cost of subcontracting $30/unit

FIGURE 9-1 Base Case Aggregate Plan for Red Tomato and Green Thumb

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All figures and analysis in this chapter come from the spreadsheet Chapter8,9-examples, which

Chapter8-trial-aggplan. The spreadsheet contains instructions for use and worksheets corre- sponding to Figures 9-1 to 9-5.

case aggregate plan for Red Tomato and Green Thumb is shown in Figure 9-1 (this is the same as discussed in Chapter 8 and shown in Table 8-4).

Total cost over planning horizon = $ 422,660 Revenue over planning horizon = $ 640,000 Profit over the planning horizon = $ 217,340

When to Promote: Peak or Off-Peak?

Green Thumb estimates that discounting a Red Tomato tool from $40 to $39 (a $1 discount) in any period results in the period demand increasing by 10 percent because of increased consump- tion or substitution. Further, 20 percent of each of the two following months’ demand is moved forward. Management would like to determine whether it is more effective to offer the discount in January or April. We analyze the two options by considering the impact of a promotion on demand and the resulting optimal aggregate plan.

IMPACT OF OFFERING A PROMOTION IN JANUARY The team first considers the impact of offering the discount in January. To simulate this option in the spreadsheet Chapter8,9-examples, enter 1 in cell E24 (this sets promotion to be on) and 1 in cell E25 (this sets the promotion in Period 1—i.e., January). The new forecast accounts for the fact that consumption will increase by 10 percent in January and 20 percent of the demand from February and March is moved for- ward to January. Thus, with a January promotion, the new demand forecast for January is obtained by adjusting the base case demand from Figure 9-1 and is given by (1,600 : 1.1) + [0.2 : (3,000 + 3,200)] = 3,000 (see Cell J5 in Figure 9-2). The new demand forecast for Febru- ary is 3,000 : 0.8 = 2,400, and the new demand forecast for March is 3,200 : 0.8 = 2,560. For

Total cost over planning horizon = $ 422,080 Revenue over planning horizon = $ 643,400

Profit over planning horizon = $ 221,320

FIGURE 9-2 Optimal Aggregate Plan When Discounting Price in January to $39

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Compared with the base case, offering a discount in January results in lower seasonal inventory, a somewhat lower total cost, and a higher total profit.

IMPACT OF OFFERING A PROMOTION IN APRIL Now, management considers the impact of offering the discount in April. To simulate this option in the spreadsheet Chapter8,9-examples, enter 1 in cell E24 (this sets promotion to be on) and 4 in cell E25 (this sets the promotion in Period 4—i.e., April). If Green Thumb offers the discount in April, the demand forecast is as

and is shown in Figure 9-3. Compared with discounting in January (Figure 9-2), discounting in April requires more capacity (in terms of workforce) and leads to a greater buildup of seasonal inventory and larger stockouts because of the big jump in demand in April. With a discount in

Total cost over planning horizon = $ 438,920 Revenue over planning horizon = $ 650,140

Profit over planning horizon = $ 211,220

a promotion in April results in a lower supply chain profit, compared with the base case of not

offer the discount in the off-peak month of January. Even though revenues are higher when the discount is offered in April, the increase in operating costs makes it a less profitable option. A promotion in January allows Red Tomato and Green Thumb to increase the profit they can share.

Note that this analysis is possible only because the retailer and manufacturer have an

our earlier statement that it is not appropriate for a supply chain to leave pricing decisions solely in the domain of retailers and aggregate planning solely in the domain of manufacturers, with each having individual forecasts. It is crucial that forecasts, pricing, and aggregate planning be coordinated in a supply chain.

optimal action is different if most of the demand increase comes from market growth or stealing market share rather than from forward buying. We now illustrate the scenario in which a discount leads to a large increase in consumption.

When to Offer a Promotion If Discount Leads to a Large Increase in Consumption

Reconsider the situation in which discounting a unit from $40 to $39 results in the period demand increasing by 100 percent (instead of the 10 percent considered in the previous analysis) because

FIGURE 9-3 Optimal Aggregate Plan When Discounting Price in April to $39

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of increased consumption or substitution. Further, 20 percent of each of the two following months’ demand is moved forward. The supply chain team wants to determine whether it is pref- erable to offer the discount in January or April under these conditions. To simulate this scenario, change the entry in cell H24 (increase in consumption) of spreadsheet Chapter8,9-examples

be on. The base case when no promotion is offered remains unchanged as shown in Figure 9-1. We now repeat the analysis for the cases in which the promotion is offered in January (off-peak) and April (peak).

IMPACT OF OFFERING A PROMOTION IN JANUARY For a January promotion, set the entry in cell E25 to 1 (Period 1, January). If the discount is offered in January, the January demand fore- cast is obtained as (1,600 : 2) + [0.2 : (3,000 + 3,200)] = 4,440. This is much higher than the same forecast in Figure 9-2 because we have assumed that consumption in the promotion month increases by 100 percent, rather than the 10 percent assumed earlier. The demand forecast for a

Total cost over planning horizon = $ 456,880 Revenue over planning horizon = $ 699,560

Profit over planning horizon = $ 242,680

higher profit than the base case (Figure 9-1).

IMPACT OF OFFERING A PROMOTION IN APRIL For an April promotion, set the entry in cell E25 to 4 (Period 4, April). If the discount is offered in April, the April demand forecast is obtained as (3,800 : 2) + [0.2 : (2,200 + 2,200)] = 8,480. With a promotion in April and a large increase in consumption, the April peak is much higher in Figure 9-5 compared with peak demand in Figure 9-4 (with a January promotion). For an April promotion with a large increase in consump-

Total cost over planning horizon = $ 536,200 Revenue over planning horizon = $ 783,520

Profit over planning horizon = $ 247,320

FIGURE 9-4 Optimal Aggregate Plan When Discounting Price in January to $39 with Large Increase in Demand

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When comparing Figures 9-5 and 9-4, observe that with an April promotion (Figure 9-5), there are no layoffs and the full workforce is maintained. The April promotion requires a much higher level of seasonal inventory and also uses stockouts and subcontracting to a greater extent than a January promotion. It is clear that costs will go up significantly with an April promotion. The interesting observation is that revenues go up even more (because of a larger consumption increase), making overall profits higher with an April promotion compared with a January pro- motion. As a result, when the increase in consumption from discounting is large and forward buying is a small part of the increase in demand from discounting, the supply chain is better off offering the discount in the peak-demand month of April, even though this action significantly increases supply chain costs.

Exactly as discussed earlier, the optimal aggregate plan and profitability can also be deter- mined for the case in which the unit price is $31 (enter 31 in cell H23) and the discounted price is $30. The results of the various instances are summarized in Table 9-3.

From the results in Table 9-3, we can draw the following conclusions regarding the impact

1. As seen in Table 9-3, average inventory increases if a promotion is run during the peak period and decreases if the promotion is run during the off-peak period.

2. Promoting during a peak-demand month may decrease overall profitability if there is a small increase in consumption and a significant fraction of the demand increase results from a forward buy. In Table 9-3, observe that running a promotion in April decreases profitability when forward buying is 20 percent and the demand increase from increased consumption and substitu- tion is 10 percent.

TABLE 9-3 Supply Chain Performance Under Different Scenarios

Regular Price

Promotion

Price

Promotion

Period

Percentage of Increase in Demand

Percentage of Forward

Buy

Profit

Average

Inventory

$40 $40 NA NA NA $217,340 875

$40 $39 January 10% 20% $221,320 515

$40 $39 April 10% 20% $211,220 932

$40 $39 January 100% 20% $242,680 232

$40 $39 April 100% 20% $247,320 1,492

$31 $31 NA NA NA $73,340 875

$31 $30 January 100% 20% $84,280 232

$31 $30 April 100% 20% $69,120 1,492

FIGURE 9-5 Optimal Aggregate Plan When Discounting Price in April to $39 with Large Increase in Demand

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