ISYE 4210 / 6600

Design and Analysis of Supply Chains

Homework Assignment #7
Chaoqun Deng 661249767

1. Discuss how air, rail, water and truck transportation differ on the following dimensions:
cost, speed and volume.
Regarding cost, air is most expensive while rail, truck and water are cheap.
Regarding speed, air is quickest while rail, truck and water are slow.
Regarding volume, air carries low volume while rail, truck and water carry high volume.

2. By offering a buyback contract to the retailer, with a properly chosen buyback price, a
manufacturer can increase the retailers order quantity. Explain why.
Manufacturer agree to buy back any excess stock at retailer at price of b per unit,
Where s<b<c, s: salvage value; c: wholesale price; p: selling price
Given buyback contract, optimal order quantity for retailer satisfies:
Pr( ) =

Pr( ) =

Since b>s, we have OB>OD

Thus, retailer orders more under the buyback contract than in decentralized supply chain without buyback.

3. Explain what is meant by aligning incentives in a supply chain. What are some of the
factors that make aligning incentives difficult?
A supply chain works well if its companies' incentives are aligned-that is, if the risks, costs, and
rewards of doing business are distributed fairly across the network (Narayanan and Raman, 2004,
p96).
There are several factors that make aligning incentives difficult: firstly, when companies cannot
observe other firms' actions, they find it hard to persuade those firms to do their best for the

supply network; secondly, it's difficult to align interests when one company has information or
knowledge that others in the supply chain don't; thirdly, incentive schemes are often badly
designed (Narayanan and Raman, 2004).

4. Do exercise 2 in Chapter 14 of the Chopra and Meindl textbook. Hint: The point of this
exercise is to evaluate the change in facility, inventory and transportation costs as a result
of using different warehouse locations. To answer this question, you should evaluate the
costs for the following three options: (1) One warehouse is built in either the eastern or
western zone (by symmetry, the costs will be the same in both cases); (2) One warehouse is
built in the central zone; and (3) A warehouse is built in each of the three zones. In
performing your analysis, note that the average weekly demand for each region is given as
50,000. This is the average number of books demanded each week, not the average number
of orders. Since orders contain 4 books (on average), the average number of orders per
week for each zone is just 50,000/4. For each of the three options to be evaluated, you will
need to calculate five different types of costs: transportation cost, cycle inventory costs,
safety inventory costs, fixed costs for the warehouse and operating costs for the warehouse.
Each of these costs should be calculated on a weekly basis and then summed to get the total
cost per week. For the cycle and safety inventory holding costs, you will find it easier to
calculate the annual holding cost and then divide by 52 weeks per year. For the safety
inventory costs, notice that Books-on-Line uses a periodic review policy in which they order
once per week. For the cycle inventory costs, notice that the average order size is equal to
the average demand per week. In the equation provided for the fixed cost of the warehouse,
x is the capacity, which can be calculated as 1.5 * (order size plus safety stock). In the
equation given for the warehouse operating cost, y is the average number of books shipped
per week.
(1) One warehouse is built in either the eastern or western zone (by symmetry, the costs will be
the same in both cases)
--Transportation Cost Per week:
The average number of orders per week for each zone is 50000/4=12500
12500*(2+3+4)= 112500
--For cycle inventory and safety inventory Cost :

Input Data (given data is in yellow)

Average demand per week
Standard deviation of demand per week
Lead time in weeks
Review time in weeks

D
s_D
L
T

50000
25000
1
1

Desired cycle service level

CSL

99.70%

Average demand during lead time + review period

Standard deviation of demand during lead time + review period

D_L+T = (L+T) D
s_L+T= sqrt(L+T) s_D

100000
35355.3

Safety stock factor

Safety stock
Order up to level

z = normsinv(CSL)
ss = z s_L+T
OUL = D_L+T + ss

1.64
58154
158154

For a given desired cycle service level

find associated required reorder point

Total Cycle Inventory per week per region

50000/2=25000
Total Safety Inventory per week per region
58154/52=1118.35
Thus, across three regions, the cycle and safety inventory holding cost per week
(25000+1118.35)*3*10*0.25=195887.6
Fixed Cost of the warehouse per week
200,000+1.5* ( 50000+1118.35)*3=200,000+230,032.57=430,032.57430,033
Warehouse Operating Cost
0.01*50000*3=1500
Total Cost per week:
112500+195887.6+430032.57+1500=739,920,17739,920

(2) One warehouse is built in the central zone

--Transportation Cost Per week:

The average number of orders per week for each zone is 50000/4=12500
12500*(3+2+3)= 100,000
--For cycle inventory and safety inventory Cost :
Total Cycle Inventory per week per region
50000/2=25000
Total Safety Inventory per week per region
58154/52=1118.35
Thus, across three regions, the cycle and safety inventory holding cost per week
(25000+1118.35)*3*10*0.25=195887.6
Fixed Cost of the warehouse per week
200,000+1.5* (50000+1118.35)*3=200,000+230,032.57=430,032.57430,033
Warehouse Operating Cost
0.01*50000*3=1500
Total Cost per week:
100,000+195887.6+430032.57+1500=727,420,17727,420

(3) A warehouse is built in each of the three zones

Transportation Cost Per week:
The average number of orders per week for each zone is 50000/4=12500
12500*(2+2+2)=75,000
For one warehouse:

--For cycle inventory and safety inventory Cost For one warehouse :
Total Cycle Inventory per week per region
50000/2=25000

Total Safety Inventory per week per region

58154/52=1118.35
Thus, the cycle and safety inventory holding cost per week
(25000+1118.35)**10*0.25=65,295.87 ,
Fixed Cost of the warehouse per week for one warehouse
200,000+1.5* (50000+1118.35)=276,677.52276,678
Warehouse Operating Cost for one warehouse
0.01*50000=500
For three warehouses :
3*(65295.87+276,677.52+500) =1,027,420.17
Total Cost per week:
100,000+1,027,420.17=1,127,420.171,127,420
Thus, transportation can be increased when inventory is aggregated. The facility cost could be increased
when inventory is not aggregated.
According to the comparison, the total cost for option 2 is the lowest. Thus, we choose to build a
warehouse in the central zone.

5. Do exercises 1 and 3 in Chapter 15 of the Chopra and Meindl textbook. For these two
problems, do the order quantity calculations by hand, i.e., write out the equations used to
find, co, cu and O*, using Excel only to look up the appropriate z value for the Normal
distribution. For the remaining parts of the problems (e.g., calculating profits, etc.), you
will need to use Excel.
Exercise 1
E1-Question a:
D=20000, = 5000
= = 24 12 = 12
= = 12 3 = 9
Pr(d ) =

12
=
= 0.57
+ 0 12 + 9

z = NormsInv(0.57) = 0.18
= + = 20000 + 0.18 5000 = 20900

Decentralized Solution - Retailer Chooses Order Quantity

Production cost per unit

$1

Wholesale price per unit

$12

Retail price per unit

$24

Salvage value per unit

$3

Cost of understocking
Cost of overstocking

Cu = p-c
Co = c-s

$12
$9

CSL = Cu/(Cu+Co)
z = NormsInv(CSL)
O_D = D + z s_D

0.57
0.18
20900

E[OS]
E[US]

2477
1577

Expected profit for retailer

(p-c) x D - Co E[OS]
- Cu E[US]

$198,784

Expected profit for supplier

(c-v) x O_D

$229,901

Optimal cycle service level

Optimal z value
Optimal order quantity
Expected overstock
Expected understock

Expected profit for system (retailer

+ supplier)

$428,685

Thus, Barnes & Nobel should order 20900 books. The expected profit for Barnes & Nobel is $198,784
It expects to sell 2477 books at a discount.

E1-Question b:
The profit for pulisher is $229,901

E1- Question c:
D=20000, = 5000

 = = 24 12 = 12
= = 12 5 = 7
Pr(d ) =

12
=
= 0.63
+ 0 12 + 7

z = NormsInv(0.63) = 0.34
= + = 20000 + 0.34 5000 = 21700

Decentralized Solution - Retailer Chooses Order Quantity - With Buyback

Production cost per unit
Wholesale price per unit
Retail price per unit
Salvage value per unit
Buyback price

v
c
p
s
b

$1
$12
$24
$3
$5

Cu = p-c
Co = c-b

$12
$7

CSL = Cu/(Cu+Co)
z = NormsInv(CSL)
O_B = D + z s_D

0.63
0.34
21680

E[OS]
E[US]

2946
1266

Expected profit for retailer

(p-c) x D - Co E[OS]
- Cu E[US]

$204,181

Expected profit for supplier

(c-v) x O_B
- (b-s) x E[OS]

$232,589

Cost of understocking
Cost of overstocking
Optimal cycle service level
Optimal z value
Optimal order quantity
Expected overstock
Expected understock

Expected profit for system (retailer

+ supplier)
Thus, under this plan, Barnes & Noble will order 21680 books.
The expected profit for Barnes & Noble will be $204,181

$436,770

2946 books are expected to be unsold.

The expected profit for publisher is $232,589
No Refund
Retailer Profits
Supplier Profits
Total SC Pofits

$198,784
$229,901

$428,685

Refund Plan
$204,181
$232,589
$436,770

Compare this two options, the buyback contract will increase both the profits of retaliers and
suppliers. Thus, the pulisher should choose this refund plan.

Exercise 3
D=5000, = 2000
= (1 ) = (1 0.35) 15 3 = 6.75
= = 3 1 = 2
Pr(d ) =

6.75
=
= 0.77
+ 0 6.75 + 2

z = NormsInv(0.77) = 0.74
= + = 5000 + 0.74 2000 = 6480

Decentralized Solution - Retailer Chooses Order Quantity -Revenue Sharing

Production cost per unit
Wholesale price per unit
Retail price per unit
Salvage value per unit

v
c
p
s

$2
$3
$15
$1

f
Cu = (1-f)p-c
Co = c-s

0.35
$6.75
$2

Optimal cycle service level

Optimal z value
Optimal order quantity

CSL = Cu/(Cu+Co)
z = NormsInv(CSL)
O_B = D + z s_D

0.77
0.74
6487

Expected overstock
Expected understock
expected sales

E[OS]
E[US]
E[Sales]
((1-f)*p-c) x D - Co
E[OS] - Cu E[US]

1752
265

Revenue sharing percentage

Cost of understocking
Cost of overstocking

Expected profit for retailer

Expected profit for supplier

(c-v) x O_B
+f*p*E[sales]

Expected profit for system (retailer

+ supplier)
a.Thus, Topgun order 6487 CDs
b. 1752 CDs Topguns should expect to sell at a discount.
c. The expected profits for Topgun are $28,455
d. The expected profits for Studio are $ 31,344
e. The results are as follows:

4735

$28,455

$31,344

$59,799

Decentralized Solution - Retailer Chooses Order Quantity -Revenue Sharing

Production cost per unit
Wholesale price per unit
Retail price per unit
Salvage value per unit

v
c
p
s

$2
$2
$15
$1

f
Cu = (1-f)p-c
Co = c-s

0.43
$6.55
$1

Optimal cycle service level

Optimal z value
Optimal order quantity

CSL = Cu/(Cu+Co)
z = NormsInv(CSL)
O_B = D + z s_D

0.87
1.11
7230

Expected overstock
Expected understock
expected sales

E[OS]
E[US]
E[Sales]
((1-f)*p-c) x D - Co
E[OS] - Cu E[US]

2363
133

Revenue sharing percentage

Cost of understocking
Cost of overstocking

Expected profit for retailer

Expected profit for supplier

(c-v) x O_B
+f*p*E[sales]

Expected profit for system (retailer

+ supplier)
Thus, Topgun order 7230 CDs
2363 CDs Topguns should expect to sell at a discount.
The expected profits for Topgun are $29,514
The expected profits for Studio are $ 31,391

4867

$29,514

$31,391

$60,905

Input Data
Product
Mean demand for season, D
Standard deviation of demand for season, s
Variance of demand for season, s^2
Sales price per unit, p
Salvage value per unit, s
Production cost per unit (without postponement), c
Production cost per unit (with postponement), c

1
2
3
4
5
20000
14000
3000
3000
3000
2000
2000
2000
2000
2000
4000000 4000000 4000000 4000000 4000000
$45
$5
$11
$12

$45
$5
$11
$12

Product
Co = cost per unit overstock = c - s
Cu = cost per unit understock = p - c
CSL (no postponement) = Cu / (Cu + Co)
z = normsinv(CSL), no postponement
O* = D + z s_D for each product
Total inventory for all 2 products

1
6
34
85%
1.04
22073
38146

2
6
34
85%
1.04
16073

Expected overstock for each product

Expected understock for each product

2228
155

2228
155

Without Postponement (player 1 and player 2)

Expected profit for product 1 and 2

Total profits

$661,347 $457,347
$1,118,695

$45
$5
$11
$12

$45
$5
$11
$12

$45
$5
$11
$12

With Postponement(player 3,4,and 5)

Mean aggregate demand = D_3 + D_4 + D_5
Variance of aggregate demand = s^2_3 + s^2_4 + s^2_5
Standard deviation of aggregate demand = sqrt(variance)

9000
12000000
3464

Co = cost per unit overstock = c - s

Cu = cost per unit understock = p - c
CSL (with postponement) = Cu / (Cu + Co)
z = normsinv(CSL), with postponement
O* = mean + z x std dev, for aggregate demand

$7
$33
83%
0.93
12238

Expected overstock
Expected understock

3564
326

Total expected profit for player 3 ,4 and 5

$261,281.61

Total expected profit for all players $1,379,976.21

For Player 3, 4 and 5, I choose to use postponement

For Player 1 and 2, I choose to use the traditional approach
The reason is that player 3, 4 and 5 has more uncertain demand than player 1 and 2. We use postponement
only for products with most uncertain demand.

References:
Narayanan, V. G., & Raman, A. (2004). Aligning incentives in supply chains. Harvard business review,
82(11), 94-102.