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Intro

02/09/2015

You are getting this mail because you are registered for
the BADM 378 class - The world class course at the College of Business!
This mail is the first in a series of about 30 emails that you all will receive
throughout the semester. The emails will comprise my notes and
observations, class slides if applicable, and general information. Please note
that if you want to email me, do not forget to put BADM 378 in the subject,
else chances are near to 100% that I will not answer; I have strong filters in
place to remove junk, and your email without that subject line would go
directly to my junk folder.
On this Wednesday, we had our introductory session. This predominantly
case-based course is built around the theme of matching supply with
demand. Class slides are attached. Note that this file is password-protected,
the password is your three digit course number. All subsequent slide files
will also be password protected, with the same password.
Class syllabus is on Compass, please let me know if you have any issues.
Your coursepacks are to be subscribed to from two sources: Study.Net and
Harvard Business Publishing; links are on Compass. The coursepacks are
complementary, and together they comprise the complete material
(including problem sheets) that we will cover in this course.
Now to next week. We will go over the basics of matching supply and
demand under uncertain scenarios in the next two sessions. For these
sessions, the note "Abdul" in your Study.Net coursepack provides the basic
material. Please come prepared to the class, after skimming through the
note. Please try to get a hard copy of the Abdul case with you.
I-Clicker : In- Class Registration on 26-Jan
As detailed in your syllabus, you are required to get the I-clicker remote for
in-class participation. I-clicker is a response system that allows you to
respond to questions I pose during class; you will be graded on that
feedback and/or participation.
You will need to register your I-clicker remote in class on 26-Jan.
I will project a Registration screen with 3 steps to follow (look for your
name, which will alphabetically scroll down the screen). Once your remote is
registered, your name will no longer appear on that scrolling list and you are
registered for the entire semester. We will use I-clicker in almost every
session in class from 26-Jan onwards, and you are responsible for bringing
your remote in every class.

If for some reason, you plan on missing the class on Jan-26, you can always
register your remote in the next class on 28th Jan. There will be no
subsequent opportunity to register. Please keep in mind that I have
programmed my base station such that Iclicker responses will NOT work
without registration. Therefore, unless your remote is registered, you will not
earn any Iclicker points.

Here are my notes on what we went through in yesterday's session.


We went further to understand the supply chain technique that tells us what
is the optimal quantity to produce when we don't know the exact demand,
but only have a distribution of demand. The tool can be used both for
discrete and continuous demand cases.
Once we have the quantity (i), we can calculate quality of service - how
often will we run out of stock, how much will we sell on an average, and so
on. For doing this, these are the steps:
1. Organize your data - mu, sigma, buying and selling prices, salvage price,
cost of reactive capacity if any.
2. Calculate Pi - Balance the costs of too much versus too little, via a tree.
The tree gives us the value of Pi - the chance of demand being higher than
the optimal point.
3. Calculate optimal quantity i - Put this value of Pi in the demand
information (discrete - like Abdul's table, or continuous - like Normal
Distribution Table A, where you calculate z) to get the optimal quantity, i. For
continuous case formula is i=mu+z*sigma.
4. Calculate Lost Sales - This happens whenever demand exceeds inventory.
In discrete case we calculate this by taking into account the cases whenever
demand will be greater than the optimal quantity i. (We are calculating the
expected number of customers who are angry). In continuous case, we
calculate by using Table B. Formula is Lost Sales(z) *Sigma.
5. Calculate Expected Sales - Deduct the expected lost sales figure (step 1)
from the mean demand (mu).
6. Calculate Salvage - These are the items left after sales. Calculate by
deducting Sales (step 2) from order (i).
7. Finally calculate profits. For this, deduct the cost of ordering, from the
revenue received from sales and salvage.
We also discussed the Laurence and Ralph case, and how Ireland option was
similar to the reactive replenishment option of Champaign newsshop of
Abdul - this option leads Abdul to moderate his initial Chicago order. Indeed,
Champaign does present an alternate supply source that can be profitably
used if demand levels exceed inventory levels. Therefore, less can be
ordered initially from Chicago. Note that although the introduction of the

Champaign option fundamentally changes the nature of the problem, it


changes the marginal analysis of the Chicago option only in one respect: it
eliminates for Abdul the risk of lost sales. There is still the potential of
ordering too much from Chicago and incurring salvage losses.
Optional Exercises for you to do :
1) Calculate optimal profits for Abdul when he does have the option of
Champaign newsshop.
2) Calculate optimal profits for L&R
(Note: I will not distribute the solutions to these optional exercises, but if
you do send me your complete working - a photo from your phone of your
handwritten working is fine - I can comment on your work. I will not
comment unless I see your effort.)
At this point, you have all the tools to start attacking problem sheet 1 in
your Study.net coursepack. I will distribute the solutions soon.
Now onto next week.
Here is how you can think about your first case --Zara -- and earn class
participation points: We will discuss this case on 2nd Feb. The case study is
in your coursepack (Study.net).
(1) Surf the firm websites and form your impressions about the current
health of business of Zara and Marks and Spencer. How have the firms been
doing since this case study was written?
(2) In their supply chain - What is it that Zara can do and Marks & Spencer
cannot? Why?
(3) Have you ever been to Zara? Marks & Spencer? Be prepared to share
your experience in class !!

I enjoyed today's class a lot! It was wonderful to find a lot of people


participating and exchanging ideas. Here are some of my thoughts on Zara
and M&S.
First we discussed how Zara's supply chain was different from that of M&S.
We talked about how fashion is constantly changing. Zara focused on
different dimensions of product (change versus quality). M&S focused much
more on process, design, and quality.
To me, Zara has indeed found out a better way to manage losses from
uncertain demand - The policy is to delay production decisions and then
respond fast: this allows one to use better forecasts, reduce mismatch costs
and increase profits. (Whenever I will use the term mismatch in this course,
I will mean mismatch of supply and demand.)
It is important to note that the associated processes of sourcing, delivery
and design are built around this supply chain model. Zara outsources only a
part of its production, but does most other things inhouse, including
purchasing raw material. This helps in two ways - it decreases costs of raw
material, and it speeds up the process.
Finally we spent some time on how Zara fights the two problems of supply
chain (remember the two problems are: i. Angry customers or lost sales
and ii. Leftover stock or inventory )
Zara's main focus is on fighting the leftover stock. As the case study details,
and as some of you pointed out, designs are not creative, they are "pulled"
from the market and customers, the firm focuses on getting things
approximately correct, and produces batch after batch after batch .........
always producing less than demand.
One of you talked about whether customers will buy even when Zara does
not have exactly what they want. Great observation, and it gives another
insight into Zara's strategy. Consider what would happen if a customer (say
Vera) goes to Zara to buy a coat. Either she likes the coat (and buys it), or
she doesn't quite like what she sees, but still buys it. Why? As a customer,
Vera knows that if she likes the coat at Zara, then she should buy it because
(a) it will not be marked down and (b) if she waits then she will have to buy
a different coat. Zara gets the sale either way. The point is - if the Zara
stores stock out of one item, they generally have another close substitute
available.
Lesson - If you dont have an adequate substitute, THEN you will have a lot
of angry customers and it is a really costly strategy. By having close

substitutes Zara also minimizes (but does not eliminate) the second problem
of supply chain.
Hope this helps. See you on Wednesday with the second darling of Fashion
industry - Benetton. For Wednesday's class, here are some questions to help
you prepare. Remember, starting Wednesday, I will call on some of you (with
randomly picked names) to participate, as the class proceeds. Read the case
carefully, and prepare well before the class.
(1) What is Benetton's approach to solving the two problems of supply chain
- excess inventory and angry customers (lost sales)?
(2) How is Benetton's approach to outsourcing different from that of Zara?
What are the pros and cons?
(3) As per the case, how does Benetton gain advantage over its competition
in Europe? Focus on the elements of logistics, manufacturing,
marketing/advertising and financial policies .

Today was a lot of fun; I thought I would put down the combined
wisdom in a mail.
The main learning from Benetton should be unambiguous:- The firm relied
on two complementary manufacturing processes. One offers significantly
lower costs than competition (reason - outsourced production); the second
provides more flexibility than competition can achieve (reason postponement of dyeing). Lesson - Flexibility is great, but it is costly.
For its production, postponing the dyeing for a minor portion of its products
allows the firm to "meet market needs". But, this is costly - dyeing is
inhouse, and there seems to be a bottleneck in capacity (Why? I hinted at
this in class, but do re-read the case to find out). On the other hand, this
"meeting the market needs" strategy lowers the cost of unsold inventory - so
Benetton saves on costs by matching supply with demand. In addition, the
subcontractors lower costs of production (even though they are the cause of
higher costs of transportation, in addition to higher lead times).
Think about Zara here. Contracting leads to slow response - Zara is fast,
because it is almost vertically integrated. But Contracting provides overall
lower costs.
Benetton's financial strategy is also interesting. The firm passes risk to
subcontractors and retailers. We discussed how the firm finances retail
inventories (payment in 30-60-90 days but guaranteed by "no return"
policy) and paid its subcontractors after 70 days. So, overall, its working
capital requirement was very low.
The firm is known for its marketing strategies as well. It relies on good
design and color palettes on retail shelves, customer access to merchandise,
chooses high traffic locations - bringing product to customer, uses vibrant
colors and fashion, multimedia advertising...
****
At this point, we have covered the analytical tools required for you to take a
shot at the problem sheet 1. (The sheet is in your Study.net course pack).
There are 3 problems - Problem 1 needs the basics discussed in session 2,
and problems 2 and 3 need the details of session 3. You should try to solve
the problems individually.
I distributed the solutions to the problem sheet in class today. My suggestion
will be to peek at the solutions only after you have made a very thorough
attempt at each problem and problem sub-parts.

Why so? If you do not attempt the problems yourself, you will never know
why you were arriving at the wrong solution!
I believe that the problems in your sheet cover a very wide variety of
situations. They are not difficult, but it is extremely tough to catch up with
problem solving later in the semester, when all your courses demand your
attention.
Please note that the problem sheet solutions are not to be submitted (and
therefore will not be graded).
Hope this helps. Please let me know if you have queries. See you on
Monday with the third case in fashion industry! Stay tuned for preparation
mail for theMonday case (Sport Obermeyer).

Attached are the main slides for Zara and Benetton sessions.
Now for Sport Obermeyer : The third fashion case to be discussed
in Monday's class. For this case, my suggestion will be to concentrate on the
case study itself, which is very rich (so web surfing is not required).
Prep Q1. Sport Obermeyer has difficulty in predicting the demand for ski
wear. What operational changes would you recommend to Wally to reduce
costs? Take a look at each of the following questions, and think about them,
with reasons and analysis, supported with case data.
(a) Where should he produce? Why? If you advocate producing both in China
and HongKong, can you analyze the case data as to how much should be
produced at these two locations?
(b) How can he improve forecasts? Use your knowledge of previous courses.
(c) How can he reduce lead-times? Which products or components require
lead-time reduction? Pick up examples from case, justify.
(d) What changes should he make in the product portfolio?
Prep Q2. What is the value that Obersport adds to the supply chain? Can
Obermeyer directly deal with Lo Village factories? Why or Why not?
Finally, as a prep for Quiz 1 (scheduled ....shezuled?) on Feb 18th: 2013
Final Exam question.
Prep Q3. You operate a small tee-shirt silk screening company. "Illinois
Professional" football team has just made it to the NFC Championship game,
which will be played in one week. You are considering selling tee-shirts with
NFC Champions blazed across the top of the shirt along with the Illini
mascot. If the team indeed wins, these shirts will sell extremely well, but if
they lose, then there will clearly be no demand for these shirts.
Unfortunately, you must print the shirts before the game because otherwise
there will not be enough time to take advantage of the hype. You estimate
that there is only a 40% chance the local team will win, but if they win, you
figure your demand will be normally distributed with mean 15000 and
standard deviation 6000. It costs $5.50 to buy and silk screen each shirt,
you will sell these shirts for $12.50 each and any leftover shirts (whether the
team wins or loses) can be sold to a liquidator for $0.50 each.
Suppose you print 18,000 shirts and suppose you get lucky and the team
wins. What is your expected profit?
I will detail the solution to this problem in the review session on Feb 16th.
Till then, practice!

As you would have felt today, we go through some pretty rigorous


sessions - that was true for Benetton on Wednesday , and also today (the
Wow at Wharton story was a bonus, of course). It was great to get a lot of
inputs from the class. My position on learning from class is simple - I do not
know as much as the class combined. And the same is true for every one of
you. That is why a class is stimulating and invigorating. As we move along,
prepare well. I will continue to cold call, it was pretty successful today.
Almost everyone was well prepared. This is what warms the heart of a
teacher!
On Obermeyer - A lot of discussion was centered around a previously
discussed lingo - "Speculative capacity" is one that is employed prior to
knowing exact demand. "Reactive capacity" is one that is employed AFTER
knowing market demand. We had earlier discussed in Abdul that Reactive
capacity can substantially reduce the demand-supply mismatch, even if it is
limited and even if it is more expensive than regular capacity. Here our focus
was on the time dimension. Note that quantity uncertainty had an additional
risk: - some products are riskier than others.
We discussed that reactive capacity should be used for riskier products.
Why? because you need to postpone the decision on the exact quantity
needed for riskier products (otherwise you may end up with 'too much'). But
if you postpone your decision, you must make it fast. Reactive capacity is
fast.
There is a specific note I want to leave you with. I drew a relationship
between Obermeyer's Mismatch costs and the amount of available reactive
capacity in today's class - right at the end. Here is some more to chew on. I
got an email from one of you, and I think some more detailed explanation is
in order.
As in the case of production minimums, mismatch costs drop rapidly with the
first few units of reactive capacity, but the marginal benefit of additional
capacity declines as the total amount of reactive capacity rises. Although the
exact shape of the curve would differ for different companies, all would
exhibit decreasing marginal returns. Why so?
The logic for this is straightforward: the first units of reactive capacity would
be used for the riskiest units, i.e., those for which the additional market
information greatly reduces the expected costs of mismatched supply and
demand. As total reactive capacity rises, the additional capacity is used to
make products whose demand is relatively easy to predict at the start of the
season. Thus, delaying production of such units (to the factory that is
reactive -e.g. HongKong) provides less benefit than delaying production of

styles with highly unpredictable demand.


So, why shouldn't we have 100% reactive or 100% flexible capacity? The
answer is that flexibility is expensive. It is very nice to say "We should have
100% flexible factories", but those factories will be very costly indeed.
We will continue on this theme - stay tuned!!. And make sure you
understand the intuition - this is simple, but not simplistic.

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