Risk Pooling Chap. 14

Risk Pooling Chap. 14 Risk Pooling Theory Applications Differentiation Postponement/Delay Location,

HP Case - handed out preparation questions 1. On page 1, it said We can t run our business with this level of unproductive assets. What are these assets? 2. What is the I-word referred to? 3. Is the ink-jet printer a commodity or fashionable product? 4. At the European DC, did HP have too much stock or too little stock? 5. What were the symptoms of the problem in the European DC? 6. When customers buy ink-jet printers, is brand/product loyalty playing an important factor in their choosing which products to buy? 7. How did the Vancouver Division impress visitors? Was the line suitable for high volume or low volume production? Why? 8. Were Ink-Jet Printers completely built in the Vancouver factory? Can a printer that was built for the Germany market be directly sold in Italy market? Why? Be precise. 9. What were the performance evaluation criteria for European DC? Should the DC manager be concerned about the inventory level? 10. What were the alternatives for resolving the inventory and service crisis?

Coefficient of Variation CV = Standard Dev / Average demand Demand series 1: CV1 = 0.5 Demand series 2: CV2 = 2.0 Which is more volatile?

Risk Pooling Which sales are more volatile: the regional sales or sales at the store level? Which demand is more volatile : a family of products or individual members of the family? Do people wait longer in a multiplewaiting-lines system than a single-waitingline system? Implication for forecasting?

Family vs. Individual Products Sales N A B C Time

Family vs. Individual Products Model Mean Stdv CV X 42 32 0.78 XX 420 203 0.46 XY 15,830 5,624 0.36 XH 2,301 1,168 0.51 XC 4,208 2,204 0.52 XY 309 103 0.34 Total 23,109 6,244 0.27

Pooling, Profit & Service Level (An Example) Two products (paints) differ only in colour It is fast to mix to the required colour upon receiving orders Assume that the demand for each follows a distribution given by tossing a dice

An Example Alternative I: Make to Stock Alternative II: Make to Order (for colouring only) Order-up-to inventory replenishment policy One season, c=$2.5, p=$12.5, s=0 For Alternative I: 5 units for each For Alternative II:?

Preliminary Calculations 1 2 3 4 5 6 1 1,1 x 2 x 3 x 4 4,3 4,5 x 5 5,4 5,5 x 6 x x x x x x Chance of stockout?

Preliminary Calculations 1 2 3 4 5 6 1 1,1 x 2 x 3 x 4 4,3 4,5 x 5 5,4 5,5 x 6 x x x x x x If D1=4, D2 =5, profit =?; If D1=6, D2=4, profit =?.

Holding 10 units of generic colour - pigment, the chance of stocking out in a period is only 3/36 = 1/12 = 0.083 The risk of disservice is lowered. Even holding 9 units, a higher level of service will be achieved (as compared with Alternative 1)

Preliminary Calculations 1 2 3 4 5 6 1 2 3 4 5 6 7 2 3 4 5 6 7 8 3 4 5 6 7 8 9 4 5 6 7 8 9 10 5 6 7 8 9 10 11 6 7 8 9 10 11 12 If D1=4, D2 =5, profit = ; If D1=6, D2=4, profit = 0. If D1=2, D2=6, profit=. Additional cost?

Theory 1, In general, ) ( 1, If ) ( 1, If ) ( 0, If ) ( 2 ) ( ) (, Let, Stdv, Mean, Two products : 2 2 2 1 2 1 2 1 2 1 2 1 2 1 2 1 d c b a x Var x mean x x x x x

Why?

Implications? Variety is the culprit of high forecasting errors, and higher forecasting accuracy can be achieved if only a few varieties are offered Since we can not reduce them, we must find a way to get around By postponing mass customisation By redesigning the product Universal products and common parts (modules)

Product Variety Proliferation Product proliferation exists in various forms global mkt: protocols, languages, phases, elec. local mkt: multiple models differ in features & capacities mkting strategies Marketing strategy is the major reason The world of The Long Tail

Pitfalls of increasing product variety

Risk pooling strategies The objective of a risk pooling strategy is to 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. Four versions of risking pooling: product pooling -- delayed differentiation/postponement location pooling lead time pooling delayed differentiation (HP case) consolidated distribution capacity pooling 14-18

Postponement Key idea - postpone the commitment of WIP into a particular finished product SKU Delay of product differentiation closer to time of sale. Prior to point of postponement, only certain degree of aggregate forecast needed Individual forecasts more accurate close to time of sale

Postponement Concepts Mainly two forms Logistics Postponement: moving customisation point closer to customers - out of mgr functions Form Postponement: delaying differentiation point by standardisation or process re-sequencing

Logistics Postponement Manufac- Integra- Customi- Locali- Packturing tion sition tion ing Supply Chain Process Factory Distribution Centers

Logistic Postponement by Process Resequencing: Paint Retail Colour pigments, paint mixing, packaging Retail sales Colour pigments, white paint Retail sales, paint mixing packaging Nippon: combined

Black Dishwasher Fib Integration+ship DC White Before module design of the metal frame Black Fab. DC+ pannel assembly Integration+ship White Operations Buffer

Log PP: More Examples Rheem Manufacturing Co., kept 120 SKUs (heaters) at its factory. Some were overstocked while other fall short - only different in several elements Using a 3rd party to hold around 10 basic models and parts Filling orders in hours and saving 15% of inventory cost Even Coffee Rosters use it Of course, PC mfgrs apply it Some done by customers. More real life examples?

PC: indirect model (traditional) Suppliers PC Company Orders Mfr factory Distribution Centers Distributor VARs Customers Configuration: Disk, memory... Product

Hybrid Model Suppliers PC Company Orders Factory: core Distribution Centers Distributor VARs Customers Assembly +Configuration Product

Other examples of delayed differentiation Private label soup manufacturer: Problem: many different private labels (Giant, Kroger, A&P, etc) 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. 14-27

Form Postponement by Common Part Before After Sometimes called standardization

Mono/Color Printers Mono PCA FA&T Customizatio Color PCA FA&T Mono Customization Operations No correlation Buffer Color

Form Postponement by Process Reengineering Series of tests and burn-in PCB Insertion Common tests Coupon PCB Customisation tests

Benetton: Process Reengineering Old Sequence Purchase Yarn New Sequence Purchase Yarn Dye Yarn Knit Garment Parts Finish Yarn Join Parts Knit Garment Parts Dye Garment This process is postponed Join Parts Finish Garment

Process Redesign for Supply Chain: Postponement at Benetton Dye yarn only after the season s fashion preferences become more established (knit lead-time much longer than dyeing lead-time). Example: single product; four colors knit dye Dyeing operations postponed knit dye Outcome: Reduces demand uncertainty & inventory

Demand correlation Correlation refers to how one random variable s outcome tends to be related to another random variable s outcome. 20 18 16 14 12 10 8 6 4 2 0 0 5 10 15 20 20 18 16 14 12 10 8 6 4 2 0 0 5 10 15 20 Random demand for two products (x-axis is product 1, y-axis is product 2). In scenario 1 (upper left graph) the correlation is 0, in scenario 2 (upper right graph) the correlation is -0.9 and in scenario 3 (the lower graph) the correlation is 0.90. In all scenarios demand is Normally distributed for each product with mean 10 and standard deviation 3. 20 18 16 14 12 10 8 6 4 2 0 0 5 10 15 20 14-33

Limitations of product pooling/universal design A universal design may not provide key functionality to consumers with special needs: High end road bikes need to be light, high end mountain bikes need to be durable. It is hard to make a single bike that performs equally well in both settings. 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: There may be a need to have different brands (e.g., Lexus vs Toyota) and different prices to cater to different segments. 14-34

Summary: When is PP Valuable? A lot of varieties Demand uncertainties over the variety are high Negatively correlated,? Positively correlated,? Differentiation is not too costly to perform locally, or not time consuming The core components have high value, but differentiating parts are of low value

Common Obstacles Though often design changes do not cost much, people resist their implementation As production cost may increase, prod. people may oppose to changes They also pose challenges to designers Indirect cost savings and intangible benefits