OPSM 451 Service Operations Management
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Transcript OPSM 451 Service Operations Management
Koç University
OPSM 305 Supply Chain Management
Class 10:
Incentive issues
Zeynep Aksin
[email protected]
1
Hamptonshire Express
Anna has a degree from journalism & operations
research
She has started a daily newspaper in her hometown
She used a leased PC: lease cost $10 per day
A local printer prints newspapers at 0.20 per copy
Sales the next day between 6 am and 10 am
Newsstand rental $30 per day
Express sold to customers at $1 per copy
Copies not sold by 10 am are discarded
Anna estimates daily demand to be distributed
N(500,100)
2
Question 1
Optimal stocking quantity?
Profit at this stocking quantity?
3
Ordering Level and Profits in Vertically
Integrated Channel
h=1; Anna sells to market directly:
i* = 584; E[Profit] = $331.33; Fill rate 98%
4
Improving demand through effort
After 6 weeks of operation, Anna thinks she
can improve demand by adding a profile
section
Experiments indicate that demand is a function
of time she invests in preparing the section
She thinks D=500 +50 h
5
Question 2
How many hours should she invest daily in
the creation of the profile section? Assume
the opportunity cost of her time is $10 per
hour.
Compare optimal profits to previous
scenario
6
Optimal Level of Effort in Vertically
Integrated Channel
Demand potential increases by 50 h
Expected profit increases by 0.8*50 h
h h+1
0.8* 50* ( h 1 h )
01
40
12
16.56
23
12.71
34
10.71
45
i* = 684
E[Profit] =
371.33
7
9.44
Delegating sales to Ralph
Anna is really busy, so asks Ralph to take-over the
retailing portion of her job.
Ralph agrees to run the newsstand from 6 AM to 10 AM
and pay the daily rent of $30
He estimates demand the next day based on viewing a
copy of the paper the previous night at 10 PM
He buys the papers from Anna at $0.8 per copy
Ralph is responsible for unsold copies at the end of the
day
8
Question 3
Assuming h=4 try to determine the optimal stocking
quantity for Ralph?
Why is this quantity different than the one in Question 2?
Now vary h in spreadsheet 3c which calculates the
optimal newsboy quantity for the differentiated channel,
i.e. to maximize Ralph’s profit.
How would changing the transfer price from the current
value of 0.8 impact Ann’s effort level and Ralph’s
stocking decision? (Spreadsheet 3d)
Compare an integrated (centralized) firm to a
differentiated (decentralized) one.
9
Ordering Level and Profits in
Differentiated Channel
Case 1. h=4; Anna sells to market directly:
i* = 684; E[Profit] = $371.33; Fill rate 98%
Case 2. h=4; Anna sells thru Ralph:
i* = 516; E[Total Profit] = $322
Anna makes $260
Ralph makes $ 62
Fill rate 84%
Why??
10
Effect of Transfer (Wholesale) Price in
Differentiated Channel
Breakdown of total profits (h=4)
400
350
300
250
ralph
$ 200
anna
150
100
50
transfer price
0.
9
0.
8
0.
7
0.
6
0.
5
0.
4
0.
3
0
11
Optimal Effort in Decentralized Channel
Optimal effort level for Anna is h=2 (and not 4).
h=2
h=4
Stocking quantity: $487
$516
Anna’s profit:
$262
$260
Ralph’s profit:
$56
$ 62
Total profit:
$318
$322
Fill rate:
83%
84%
Why??
12
Inefficiencies in a Differentiated Channel
Supplier chooses w, retailer chooses i*
Retail ignores +ve effect of stocking one more
unit on supplier
Supplier ignores +ve effect of cutting
wholesale price/increasing effort on retailer
Supplier prices above marginal cost/exerts
low effort
Retailer stocks less
Supply chain profits shrink
13
Contracts
Specifies the parameters within which a buyer
places orders and a supplier fulfills them
Example parameters: quantity, price, time, quality
Double marginalization: buyer and seller make
decisions acting independently instead of acting
together; both of them make a margin on the
same sale – gap between potential total supply
chain profits and actual supply chain profits
results
Buyback contracts can be offered that will
increase total supply chain profit
14
Returns policies
Rationale: set buyback price b so that
(retailer cost structure
wb c s
= supply cost structure)
r b r s
Supplier can use both w and b
Supplier is bundling insurance with the
good
15
Example
Breakdown of profits under a
buyback scheme
8
0.
77
0.
74
0.
71
0.
6
0.
45
0.
3
0.
15
ralph
anna
0.
0
400
350
300
250
$ 200
150
100
50
0
buyback price
16
Reasons for return policies
Supplier is less risk averse than
retailers
Supplier has a higher salvage value
Safeguarding the brand
Signalling information
Avoiding brand switching
17
Costs of Return Policies
Extra transportation and handling
Extra depreciation
Getting the return rate wrong
Retailer incentives
18
The case of books
Returns as in Hamptonshire Express…
…However publisher has no control of return
quantities
No control of inventory-shelf arrangements
No control over private-label
No control of retail price
Key difference: power has shifted from publisher
to retailer
19
Video sales
Hollywood: video rentals and sales
$20B business, and largest source of
revenue
Rentals slipping
– Competition from direct services
– Customer dissatisfaction (20% cannot rent
video they want on a typical trip)
What’s the problem? Bad forecasting?
Inefficient replenishment?
20
Revenue Sharing
Reduce wholesale price in return for a
share of revenues
Encourages retailers to stock more
$60 a tape
– $3/rental – rent each tape 20 times to break
even
$9 a tape, studio receives half revenue
– $3/rental – rent each tape 6 times to break
even
Retailer stocks more
21
Revenue sharing
When does it work?
– marginal cost of increasing inventory low
– administrative burden low
– for price-sensitive products
22
The Impact of Revenue Sharing
Blockbuster Instituted the “Go Home
Happy” marketing initiative
Results
– Store traffic went up
– Market share 4th quarter 98 = 26%
– Market share 2nd quarter 99 = 31%
– Revenue in 2nd quarter 99: +17% from 98
– Cash flow in 2nd quarter 99: +61% from 98
23
Other Contracts
Quantity Flexibility Contracts
– Supplier provides full refund for returned
items as long as the number of returns is no
larger than a certain quantity
Sales Rebate Contracts
– Supplier provides direct incentive for the
retailer to increase sales by means of a
rebate paid by the supplier for any item sold
above a certain quantity
24
Vendor-Managed Inventories (VMI)
Manufacturer or supplier is responsible for all decisions
regarding inventory at the retailer
Control of replenishment decisions moves to the
manufacturer
Requires that the retailer share demand information
with the manufacturer
Manufacturer can increase its profits and total supply
chain profits by reducing effects of double
marginalization
Having final customer demand data also helps
manufacturer plan production more effectively
Potential drawback – when retailers sell products that
are substitutes in customers’ minds
25
Information-based Solutions
Measure more variables to reduce moral
hazard; e.g. scan-based promotions,
“mystery shoppers”
Reduce pre-contact private information
– Credit rating companies, personal contacts,
long term contracts
26
Trust-based solutions
Use of intermediaries
Reputation
Relationship contracts
– Defining process for renegotiation
27
On Trust..
Can only “trust” people/firms to do
what’s in their best interest
Align incentives/procedures so
that agent responses lead to revenue
growth/cost reduction for all
Have mechanism to share
gains
28
Supply Chain Coordination (Source: A. Raman)
Good supply chain management involves
thinking like an engineer («people are dumb but
honest »)
Streamline processes
Educate employees/partners in benefits
And like an economist (« people are dishonest
but smart »)
Consider changing incentive structure
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