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# The following Newsboy problem, with variations, is solved on subsequent pages of this text.

Nine West (a shoe manufacturer) currently allows shoe retailers to place an order in August for delivery in November for the ho We will consider only one shoe: the black size-6 TC (Toe-Cruncher), a new shoe just coming to market. It costs Nine West \$6.50 to manufacture and ship each TC. Nine West charges a wholesale price of \$35. The manager at one retailer, Nordstrom, plans to sell the shoe for \$75. At this price, demand for the TC is estimated to be nor with a mean of 8000 and a standard deviation of 3500.

## 1. How many TCs should the manager at Nordstrom order?

This problem is called the newsboy problem, or the single period problem. The implication is that any TC that Nordstrom fa during the holiday season essentially becomes a \$35 loss. On the other hand, if Nordstrom stocks too few TCs, lost sales ma The solution is to purchase an amount of stock that balances the risk of lost sales with the risk of overstock. The optimal stock is indicated by the formula "ServiceLevel = X / (X+Y)", where X=the cost of understocking by one unit, and Y The ServiceLevel is the probability that actual demand will be less than your stocking level.

## 2. How much profit does Nordstrom expect to make as a result?

The derivation of this answer is much more difficult than it may look at first. The expected profit is an integral of profit*probabil ranging over the various levels of demand that may occur. The following spreadsheet shows an exact formula to get the resul but you can also approximate the number fairly well with a table in Excel, byreaking the different possible levels of demand into

## 3. How much profit will Nine West make as a result?

This is easy, if you have the answer to #1, above.

## 4. What is the resulting supply chain profit?

Sum your answers to #2 and #3.

## 5. What order quantity would maximize supply chain profits?

This question leads to a deeper insight. The stocking level that Nordstrom uses is chosen to optimize Nordstrom profits. Obviously, Nine Wests profits would be higher if Nordstrom would order more product. But to order more product would burden Nordstrom with additional risk that is not counterbalanced by an adequate probability of potential gain. But maybe Nine West could offer to absorb some of that additional risk somehow. We would like to know how much additional potential profit is out there? To answer this question, you could experiment with the spreadsheet you created to solve problem #2, maximizing the value that results in problem #4. If you know the formula to calculate the retailer's expected profit directly, then you could solve the problem quickly by pretendin to combine NineWest and Nordstrom into a single company for purposes of this analysis.

6. Can you devise a buyback contract that Nine West can offer to induce the manager at Nordstrom to orde

A buyback is one type of contract in which supply chain partners share risk. We will discuss others also. In a buyback, Nine West would offer to take back unsold units at a pre-determined price. The buyback offer has the effect of lowering the value of Y in problem #1 above, thus raising the CSL. This problem is difficult, because you must assess the expected cost that Nine West will incur when Nordstrom exercises the b For this problem, ignore real-life costs like shipping and handling.

## TC is estimated to be normally distributed,

any TC that Nordstrom fails to sell oo few TCs, lost sales may result.

## tocking by one unit, and Y=the cost of overstocking by one unit.

n integral of profit*probability, ct formula to get the result, sible levels of demand into pieces and perform a crude probabilistic sum..

## Nordstrom exercises the buyback option on unsold units.

GIVEN Mean: Standard Deviation: Manufacturing Cost: Wholesale Price: Nordstrom Price: Buyback Value: Supply Chain Cs: Supply Chain Ce: Cs: Ce: CSL: #1 Q*: (Q-Mean)/Std. Deviation F(Q*): f(Q*): #2 Expected Profit(Retail): #3 Expected Profit(Manuf): #4 Supply Chain Profit:

8000 3500 \$6.50 \$35.00 \$75.00 \$0.00 x x \$40.00 \$35.00 53.3% 8292.78 0.08 0.53 0.40 \$215,643.41 \$236,344.26 \$451,987.67

#5

MAXIMUM SUPPLY CHAIN PROFIT 8000 3500 \$6.50 \$35.00 \$75.00 \$0.00 \$68.50 \$6.50 \$40.00 \$35.00 91.3% 12765.5 1.36 0.91 0.16 \$142,737.98 \$363,816.70 \$506,554.69

#6

This spreadsheet demonstrates the solution to the "risk-pooling" problem associated with Nordstrom and Nine West. The formulae used to calculate expected profit to the retailer and manufacturer are somewhat complex, but can be used in any buyback consideration. For additional insight into this topic, look up the very good "Supply Chain" text written by Chopra and Meindl Please see the following pages for formulae and tables to solve this problem.

OPTIMAL PROFIT TO NINE WEST, WITH BUYBACK INCENTIVE FOR NORDSTROM 8000 3500 \$6.50 \$35.00 \$75.00 \$9.69 x x \$40.00 \$25.31 61.2% 9000.11 0.29 0.61 0.38 \$232,455.76 \$237,578.85 \$470,034.61

Nordstrom and Nine West. what complex, but can be used in Supply Chain" text written by Chopra and Meindl.

As seen on the "solutions" page of this workbook, the buyback analysis in the newsboy problem can be solved very quickly with the right formulae. Here they are, for the case where demand is Normal: These parameters will be needed: MeanDemand Sigma Cs, the cost the retailer suffers for a shortage. Ce, the cost the retailer suffers for an excess unit. The retailer should stock at a service level of CSL=Cs/(Cs+Ce) The retailer should order Q units from the wholesaler, where Q = NORMINV(CSL, MeanDemand, Sigma) The formula for the retailer's profit is very complex. It is related to an integral I will describe in class: Given a stock of Q units, the retailer can expect a profit of: Retail Profit = (Cs+Ce)*MeanDemand*F(Q) - (Cs+Ce)*Sigma*f(Q) - Q*Ce*F(Q) +Q*Cs*(1-F(Q)) where F(Q) = NORMDIST(Q,MeandDemand,Sigma,1). and f(Q) = NORMDIST((Q-MeanDemand)/Sigma,0,1,0) [If Q was found with the CSL then F(Q)=CSL]. You can see this formula used in row 17 of the "solutions" spreadsheet. If the wholesaler/manufacturer offers a buyback contract, then the Ce value for the retailer is changed, and a new value of Q should result. But it also makes it difficult to calculate the expected profit for the wholesaler/manufacturer, because we must now take into account the number of buybacks that might be exercised. We need these parameters: b, the \$value of the buyback p, the price the retailer pays to the wholesaler/manufacturer c, the cost the wholesaler/manufacturer pays to acquire or produce each unit. The formula for the wholesaler/manufacturer's profit, given that the retailer purchase Q units, is: Wholesale/Manufacturer Profit = (p-c)*Q - b*((Q-MeanDemand)*F(Q) + Sigma*f(Q)) You can see this formula used in row 19 of the "solutions" spreadsheet.

here demand

Demand, Sigma)

(Q) +Q*Cs*(1-F(Q))

r is changed, and

ks that might

This table shows how the calculations of profit could have been estimated. The equations in rows 17 and 19 of the "solutions" for the homework you did not have that formula, and would have had to use a built-up estimate like this. To manipulate this sheet, experiment with the value of b. Q 9000 p \$35.00 CSL 61% Mean 8000 cost \$6.50 Cs \$40.00 Sigma 3500 b \$9.69 Ce \$25.31 Demand 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 5500 6000 6500 7000 7500 8000 8500 9000 9500 10000 10500 11000 11500 12000 12500 13000 13500 14000 14500 15000 15500 16000 Sales 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 5500 6000 6500 7000 7500 8000 8500 9000 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 9000.11 Leftover ManufProfit RetailProfit Probability (range) Retailprofit*Prob 9000.11 169292.08 -227792.8 1.34% \$(3,053.46) 8500.11 174137.08 -195137.8 0.58% \$(1,122.98) 8000.11 178982.08 -162482.8 0.77% \$(1,256.42) 7500.11 183827.08 -129827.8 1.02% \$(1,321.74) 7000.11 188672.08 -97172.8 1.31% \$(1,276.22) 6500.11 193517.08 -64517.8 1.66% \$(1,071.06) 6000.11 198362.08 -31862.8 2.06% \$(655.12) 5500.11 203207.08 792.2 2.50% \$19.77 5000.11 208052.08 33447.2 2.97% \$992.35 4500.11 212897.08 66102.2 3.46% \$2,284.97 4000.11 217742.08 98757.2 3.95% \$3,897.14 3500.11 222587.08 131412.2 4.41% \$5,800.66 3000.11 227432.08 164067.2 4.84% \$7,937.43 2500.11 232277.08 196722.2 5.20% \$10,220.68 2000.11 237122.08 229377.2 5.47% \$12,539.98 1500.11 241967.08 262032.2 5.64% \$14,769.76 1000.11 246812.08 294687.2 5.69% \$16,780.47 500.11 251657.08 327342.2 5.64% \$18,451.04 0.11 256502.08 359997.2 5.47% \$19,680.94 0 256503.16 360004.43 5.20% \$18,703.99 0 256503.16 360004.43 4.84% \$17,416.70 0 256503.16 360004.43 4.41% \$15,890.94 0 256503.16 360004.43 3.95% \$14,206.43 0 256503.16 360004.43 3.46% \$12,444.36 0 256503.16 360004.43 2.97% \$10,681.00 0 256503.16 360004.43 2.50% \$8,982.62 0 256503.16 360004.43 2.06% \$7,401.95 0 256503.16 360004.43 1.66% \$5,976.42 0 256503.16 360004.43 1.31% \$4,728.11 0 256503.16 360004.43 1.02% \$3,665.10 0 256503.16 360004.43 0.77% \$2,783.79 0 256503.16 360004.43 0.58% \$2,071.76 0 256503.16 360004.43 1.34% \$4,825.70

ons in rows 17 and 19 of the "solutions" sheet are superior to this table, but estimate like this.

Manufprofit*Prob \$2,269.29 \$1,002.13 \$1,384.01 \$1,871.49 \$2,477.92 \$3,212.57 \$4,078.47 \$5,070.30 \$6,172.71 \$7,359.26 \$8,592.50 \$9,825.21 \$11,002.97 \$12,067.93 \$12,963.39 \$13,638.77 \$14,054.30 \$14,184.96 \$14,022.89 \$13,326.59 \$12,409.40 \$11,322.29 \$10,122.08 \$8,866.60 \$7,610.21 \$6,400.11 \$5,273.89 \$4,258.20 \$3,368.78 \$2,611.39 \$1,983.45 \$1,476.13 \$3,438.31

Estimate of Expected Profit for Retail \$233,397.05 Compare to row 17 in the "solutions" sheet. Estimate of Expected Profit for Manufacturer \$237,718.51 Compare to row 19 in the "solutions" sheet.