Risk Pooling Strategies to Reduce and Hedge Uncertainty
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1 Risk Pooling Strategies to Reduce and Hedge Uncertainty Location Pooling Product Pooling Lead time Pooling Capacity Pooling Risk Pooling 風 險 共 擔 : 整 合 供 應 以 減 少 因 需 求 波 動 而 缺 貨 的 風 險 D ~N(, ) D +D ~N( +, ) Store Store Store Store D ~N(, )
2 Risk Pooling Strategies Redesign the supply chain, the production process, or the product to either reduce the uncertainty the firm faces or to hedge uncertainty so that the firm is in a better position to mitigate the consequence of uncertainty. location pooling product pooling lead time pooling consolidated distribution delayed differentiation capacity pooling. Location Pooling at Medtronic Current operations: Each sales representative has her own inventory Lead time is day from Mounds View DC The location pooling strategy: A single location stores inventory used by several sales reps. Inventory is automatically replenished at the pooled location as depleted by demand. Lead time to pooled location is still day. DC DC Territory Territory Territory Territory Territory Territory
3 The Impact of Location Pooling on Inventory Suppose each territory s expected daily demand is 0., the required in stock probability is.% and the lead time is day. Number of territories pooled Pooled territory's expected demand per day (a) Expected inventory But pooling has no impact on pipeline inventory. Pipeline inventory days-ofdemand (b/a) days-ofdemand (c/a) S units (b) units (c) The Inventory-Service Tradeoff Curve Location pooling can be used to decrease inventory while holding service constant, or increase service while holding inventory cost, or a combination of inventory reduction and service increase. Expected inventory (days of demand) In-stock probability
4 Why Does Location Pooling Work? Location pooling reduces demand uncertainty as measured with the coefficient of variation. Expected inventory in days of demand Reduced demand.0 uncertainty reduces the inventory needed to achieve.0 a target service level 0.0 inventory C.V. 0 Number of territories pooled Coefficient of variatio Pros and Cons of Location Pooling Pros: Reduces demand uncertainty which allows firms such as e tailers to reduce inventory, increase service, expand the product line, or a combination of all three. Cons: Moves inventory away from customers. Inconvenience for the sales reps. May create costs to ship product to customers, but may reduce inbound transportation. Amazon is moving back to multiple inventory locations to accelerate the delivery times.
5 Alternatives of Location Pooling Virtual pooling: Each Medtronic rep keeps her own inventory, but shares inventory with nearby reps if needed. DC 正 常 補 貨 水 平 轉 運 Dealer Dealer Dealer transshipment Alternatives of Location Pooling Drop shipping: If a firm doesn t have enough demand at each location to justify holding inventory, the firm can location pool with other firms Factory DC DC
6 . Product Pooling Universal Design O Neill sells two Hammer / wetsuits that are identical except for the logo silk screened on the chest. Surf Hammer / logo Dive Hammer / logo O Neill could consolidate its product line into a single Hammer / suit, i.e., a universal design. Product Pooling Analysis Assumptions Demand for the Surf Hammer is Normally distributed with mean and standard deviation. Demand for the Dive Hammer has the same distribution. Surf and Dive demands are independent then the Universal Hammer s demand has mean x = and std deviation = sqrt() x = 0. Price, cost and salvage value are the same: Hence, C o is 0 = 0, C u = = 0 Same critical ratio = 0 /(0 + 0) = 0. Same optimal z statistic, 0.
7 Product Pooling Analysis Results Performance of the two suits (Surf and Dive) Total order quantity = x = 0 Total profit = x $,0 = $,0 Universal Hammer Order quantity: Q z Expected profit C u Expected sales C o Expected left over inventory $0, Reduces inventory by (0 0)/0 =.% Increase profit by (0 0)/0 =.% The profit increase of.% =.% of revenue Demand Correlation Correlation refers to how one random variable s outcome tends to be related to another random variable s outcome
8 Key Driver of Product Pooling Product pooling is most effective if coefficient of variation of the Universal product is lower. COV for Surf and Dive Hammers = / = 0. COV for Universal Hammer = 0/ = 0. Negative correlation in demand for the individual products is best for reducing COV Expected profit Correlation COV of pooleddemand Correlation Coefficient of variation Limitations of Product Pooling A universal design may not provide key functionality to consumers with special needs: A universal design may be more expensive to produce because additional functionality may require additional components. But a universal design may be less expensive to produce/procure because each component is needed in a larger volume. A universal design may eliminate brand/price segmentation opportunities:
9 . Lead time pooling: consolidated distribution Weekly demand at each store is Poisson with mean 0. and the target in stock probability at each store is.% S u p p l i e r S u p p l i e r C u r r e n t s y s t e m : d i r e c t f r o m s u p p l i e r w e e k l e a d t i m e. R e t a i l D C S t o r e S t o r e 0 0 P r o p o s e d s y s t e m : c e n t r a l i z e d i n v e n t o r y i n a d i s t r i b u t i o n c e n t e r w e e k w e e k le a d tim e le a d tim e across S t o r e stores, then DC demand. DC demand is normally distributed with mean 0 and standard deviation If demands were independent would have a standard S t o r e 0 0 deviation of sqrt(0) =.0 Consolidation with Centralized Inventory C urrent system : direct from supplier w eek lead tim e S u p p l i e r. S t o r e S t o r e 0 0 P r o p o s e d s y s t e m : c e n t r a l i z e d i n v e n t o r y i n a d i s t r i b u t i o n c e n t e r w e e k w eek lead tim e le a d tim e R e t a i l S u p p l i e r D C. S t o r e S t o r e 0 0 Direct delivery supply chain Centralized inventory supply chain Location pooling Expected total inventory at the stores Expected inventory at the DC 0 Pipeline inventory between the DC and the stores Total 0
10 Consolidated Distribution Results reduces retail inventory by more than 0%! reduces inventory even though the total lead time increases from to weeks! is not as effective at reducing inventory as location pooling but consolidated distribution keeps inventory near demand, thereby avoiding additional shipping costs (to customers) and allowing customers to look and feel the product. 0 Consolidated Distribution: other benefits The supply chain only needs to decide the total quantity to ship from the supplier, not a total quantity and its allocation across locations. Hence, uncertainty is reduced. Most effective if demands are negatively correlated across locations. Most effective if the supplier lead time is long and the DC to store lead time is short. Easier to obtain quantity discounts in purchasing. Easier to obtain economies of scale in transportation:
11 Lead Time Pooling: Delayed Differentiation Delayed differentiation is an alternative to product pooling O Neill stocks generic Hammers that have no logo. When demand occurs O Neill quickly silk screens on the appropriate logo, i.e., the Surf Hammer and the Dive Hammer are still offered. When does delayed differentiation make sense: Customers demand variety. There is less uncertainty with total demand than demand for individual versions. Variety can be added quickly and cheaply. Delayed Differentiation with Retail Paint color pigments, paint mixing, packaging retail sales color pigments retail sales, paint mixing, packaging
12 Delayed Differentiation: Process Postponement Dyed Yarns Finished Sweaters Dyeing Knitting White Garments Finished Sweaters Knitting Dyeing Other Examples of Delayed Differentiation Private label soup manufacturer Problem: many different private labels Solution: Hold inventory in cans without labels, add label only when demand is realized. Black and Decker Sell the same drill to different retailers that want different packaging. Store drills and package only when demand is realized. Nokia Customers want different color phones. Design the product so that color plates can be added quickly and locally.
13 . Capacity Pooling: Flexible Manufacturing The more links in the configuration, the more flexibility constructed. Plant links: No flexibility Vehicle Plant links Vehicle Plant links Vehicle Plant 0 links: Total flexibility Vehicle A A A A B B B B C C C C D D D D E E E E F F F F G G G G H H H H I I I I J J J J Heijunka: workload leveling 根 據 實 際 需 求 安 排 生 產 計 劃, 使 生 產 量 與 生 產 內 容 平 準 化 當 月 計 劃 生 產 00A 00B 00C 每 週 生 產 00A 0B 0C 每 天 生 產 0A 0B 0C 實 際 現 場 排 程 AAAABBBCC AAAABBBCC mixed model production
14 Flexibility Increases Utilization and Sales 00 0 Total flexibility 0 links Plant 0 links Vehicle A B Plant 0 links: Total flexibility Vehicle A B Expected sales, units 00 0 links links No flexibility C D E F G C D E F G Expected capacity utilization, % H I J H I J Flexibility vs. Cost of Capacity Expected sales, units C=00 C=0 No flexibility C = total capacity of all ten plants C=0 C=00 C=0 0 links, chain C=0 C= Expected capacity utilization, % Flexibility is most valuable when capacity approximately equals expected demand. Flexibility is least valuable when capacity is very high or very low. If flexibility is cheap relative to capacity, add flexibility. But if flexibility is expensive relative to capacity, add capacity.
15 Risk pooling strategies are most effective when demands are negatively correlated. With location pooling, the biggest bang is from pooling only a few locations With capacity pooling, a little flexibility performs almost as good as full flexibility. Risk pooling allows a firm to lower inventory and increase service simultaneously. 0
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