Summary Ch.

13
13.1 THE IMPORTANCE OF THE LEVEL OF PRODUCT AVAILABILITY
The level of product availability is measured using the cycle service level or the fill
rate, which are metrics for the amount of customer demand satisfied from available
inventory. The level of product availability, also referred to as the customer service
level, is one of the primary measures of a supply chains responsiveness. A supply
chain can use a high level of product availability to improve its responsiveness and
attract customers, thus increasing revenue for the supply chain. However, a high level
of product availability requires large inventories, which raise supply chain costs.
Therefore, a supply chain must achieve a balance between the level of availability and
the cost of inventory. The optimal level of product availability is one that maximizes
supply chain profitability.
Whether the optimal level of availability is high or low depends on where a particular
company believes it can maximize profits. Nordstrom has focused on providing a high
level of product availability and has used its reputation for responsiveness to become
a successful department store chain. However, prices at Nordstrom are higher than at
a discount store, where the level of product availability is lower. Power plants ensure
that they (almost) never run out of fuel because a shutdown is extremely expensive,
resulting in several days of lost production. Some power plants try to maintain several
months of fuel supply to avoid any probability of running out. In contrast, most
supermarkets carry only a few days supply of product, and out-of-stock situations do
occur with some frequency.
13.2 FACTORS AFFECTING OPTIMAL LEVEL OF PRODUCT AVAILABILITY
Buyers must balance the loss from having too many unsold items (in case the number
of items ordered to the manufacturer is more than demand) and the lost profit from
turning away customers (in case the number of items ordered is less than demand)
when deciding the level of product availability.
In summary, the two key factors that influence the optimal level of product availability
are:
Cost of overstocking the product
Cost of understocking the product
The cost of overstocking is denoted by Co and is the loss incurred by a firm for each
unsold unit at the end of the selling season. The cost of understocking is denoted by
Cu and is the margin lost by a firm for each lost sale because there is no inventory on
hand. The cost of understocking should include the margin lost from current as well as
future sales if the customer does not return.
N.B. Deciding on an optimal level of product availability makes sense only in the
context of demand uncertainty. Traditionally, many firms have forecast a consensus
estimate of demand without any measure of uncertainty. In this setting, firms do not
make a decision regarding the level of availability; they simply order the consensus
forecast. Over the past decade, firms have developed a better appreciation for
uncertainty and have started developing forecasts that include a measure of
uncertainty. Incorporating uncertainty and deciding on the optimal level of product
availability can increase profits relative to using a consensus forecast.

13.3 MANAGERIAL LEVERS TO IMPROVE SUPPLY CHAIN PROFITABILITY

Two obvious managerial levers to increase profitability are
1. Increasing the salvage value of each unit increases profitability (as well as the
optimal cycle service level).
2. Decreasing the margin lost from a stockout increases profitability (by allowing a
lower optimal cycle service level).
How to deal with each of them?
1. Strategies to increase the salvage value include selling to outlet stores (e.g. online
liquidators or stores in other parts of the world where climate seasons differ) so that
leftover units are not merely discarded. Increasing the salvage value of leftover
units allows a firm to grow profits by providing a higher level of product availability
because the cost of excess inventory has been reduced.
2. a) Strategies to decrease the margin lost in a stockout include arranging for backup
sourcing (which may be more expensive) so customers are not lost forever practice
of purchasing product from a competitor on the open market to satisfy customer
demand.
b) The cost of understocking can also be decreased by providing the customer with a
substitute product. Decreasing the cost of understocking allows a firm to increase
profits by providing a lower level of product availability (because there are alternatives
available to serve the customer), thus decreasing the amount of excess inventory at
the end of the season.
Another significant managerial lever to improve supply chain profitability is the
reduction of demand uncertainty. With reduced demand uncertainty, a supply chain
manager can better match supply and demand by reducing both overstocking and
understocking. A manager can reduce demand uncertainty via the following means:
1. Improved forecasting: Use better market intelligence and collaboration to reduce
demand uncertainty.
Improving forecasts can be obtained through:

Better understanding of customers

Action coordination with the supply chain
Use of demand planning information systems

An increase in forecast accuracy decreases both the overstocked and

understocked quantity and increases a firms profits.
2. Quick response: is the set of actions a supply chain takes to reduce the
replenishment lead time, so that multiple orders may be placed in the selling season.
Supply chain managers are able to improve their forecast accuracy as lead times
decrease, which allows them to better match supply with demand and increase supply
chain profitability. In fact, it is difficult for a buyer to make an accurate forecast of
demand too far in advance. This results in high-demand uncertainty, leading the buyer

to order either too many or too few items each year. Typically, buyers are able to make
accurate forecasts once they have observed sales for the first week or two in the
season. If lead times can be shortened to facilitate the use of actual sales when
placing part of the seasonal order, there can be significant benefits for the supply
chain. We can observe three important consequences of being able to place a second
replenishment order in the season after observing some sales:
1. The expected total quantity ordered during the season with two orders is less than
that with a single order for the same cycle service level. In other words, it is possible
to provide the same level of product availability to the customer with less inventory if
a second, follow up order is allowed after observing some sales.
2. The average overstock to be disposed of at the end of the sales season is less if a
follow-up order is allowed after observing some sales.
3. The profits are higher when a follow-up order is allowed during the sales season.
If quick response allows multiple replenishment orders in the season, profits
increase and the overstock and understock quantity decreases. Multiple
replenishments allow the supply chain to better match supply and demand by being
able to respond to trends rather than having to forecast them.
N.B. From our previous discussion, quick response is clearly advantageous to a retailer
in a supply chainwith one caveat. As the manufacturer reduces replenishment lead
times, allowing for a second order, we have seen that the retailers order size drops. In
effect, the manufacturer sells less to the retailer. Thus, quick response results in the
manufacturer making a lower profit in the short term if all else is unchanged. This is an
important point to consider, because decreasing replenishment lead times requires
tremendous effort from the manufacturer, yet seems to benefit the retailer at the
expense of the manufacturer.
3. Postponement: In a multiproduct setting, postpone product differentiation until
closer to the point of sale.
4. Tailored sourcing: Use a low lead time, but perhaps an expensive supplier as a
backup for a low-cost but perhaps long lead time supplier.