Question 1
- Describe the different types of costs associated with inventory.
Inventory costs can be divided into three main categories, namely purchase costs (the cost of procurement), storage costs (maintenance) and costs related to the lack of goods (shrinkage). Purchase costs (also called as the costs of order preparation, especially when it comes to production), or restocking are economic consequences caused by direct orders, that is, costs that arise every time the company place customer’s order. These costs can be divided into two parts: the costs directly for the placement of the order (they can be persistent and do not depend on the order quantity) and logistics costs of incoming flows (freight and acceptance (unloading and inspection) of goods). Storage costs are very important in “static” analysis of stocks, that is, when attention is paid to keeping more or fewer goods, irrespective of their movements. Storage costs can be cost of capital (or financial costs), costs for warehouses, service expense reserves and inventory risks. Shrinkage incurred in the absence of goods to retailers may include the costs of emergency supplies, changing suppliers to those who work more quickly, transition to less profitable products, etc. Such costs can be calculated fairly accurately, but some of the other is difficult to determine, for example, loss of profits due to the loss of the buyer or reduce the company’s reputation.
- Explain the relative merits of the Reorder Point and Reorder Cycle inventory management methods. Give examples of two types of situation suited to Reorder Point and two types of situation suited to Reorder Cycle.
Reorder Point is the amount of goods for which it is necessary to do another purchase order. The Reorder Point can be set at the level of the minimum reserve if the supplier reliable and clearly fulfills the conditions of delivery, or with the safety stock, if during the implementation of supply there may be unforeseen circumstances that lead to a break in the flow of goods. The size of the safety stock should be considered if changes in demand are expected due to seasonality. So, the Reorder Point merits are in the mechanization and optimization through developing a cycle of buying that maintains company’s inventory system stored in order it could correspond customer demand. Reorder Point should be used during the planning of purchasing the amount of goods and making orders by suppliers.
The delay, called the Reorder Cycle, is the time between placing an order and delivery of goods ordered. Knowledge of the Reorder Cycle allows determining the most appropriate time of order placement. For example, consider a situation where the demand for goods is constant and is 10 units per day, and the turnaround time for this product is three days. During the execution of the order requirement is 30 units. Therefore, in order to avoid a deficit at the time of placing the order stock should be at least 30 units of goods. This level of reserves is called Reorder Point. In principle, if the demand is constant (B), and the Reorder Cycle is I, while the level at which placing an order should happen in order to avoid a deficit will be BI. Ambiguities in the organization of the Reorder Cycle can lead to tragic consequences like downtime.
Question 2
- What are the potential risks associated with having too much capacity?
Risks can be the following: decrease in company’s profitability, in the amount of profit in industry and inability to meet debt obligations. In addition, there is a tension in the foreign trade, as producers sell excess production abroad at low prices.
- What are the potential risks associated with having too little capacity?
Production due to the capacity crunch is unable to meet the increased demand, this leads to higher prices for the same, not increasing, production of goods.
There are three strategies for production planning, which use three variables, namely labor, working hours and the amount of inventory.
1. Chase demand strategy will harmonize the rate of production to the volume of orders by hiring or dismissal of the labor force in response to changes in orders. This strategy allows adapting to almost any demand fluctuations with a slight delay in the adaptation of workers.
2. The strategy of flexible working time. With this strategy the variable, offsetting fluctuations in demand, is working time at a constant number of employees. Production rate varies with a flexible work schedule, providing both downtime at low demand and overtime – at high level of demand. This strategy allows adjusting to small fluctuations in demand and to avoid the costs of hiring and dismissal of workers.
3. Level capacity strategy is based on maintaining a constant labor force at a constant level of production. Shortage and surplus of products are smoothed by change in the level of inventories, orders and loss of redundancy in sales. Personnel is beneficial by stable loading of working time, despite the fact that it is achieved at the cost of reducing the level of service customers and increase storage costs of inventories. It should be borne in mind that stored reserves may become outdated.
If for smoothing fluctuations in demand one of the above variables is used, the appropriate strategy is called pure if used more – then mixed. Most often in practice, a mixed strategy is used.
Question 3
- Using a suitable step-response diagram and a suitable noise-response diagram, explain the effect of the smoothing constant (typically denoted by ) when using exponential smoothing to forecast demand, and therefore the compromise that is made in selecting a particular value.
One of the most effective ways to short-term forecasting of demand is forecasting based on exponential smoothing. This method is based on the calculation of the weighted average sales for a number of past periods and in the short term is very useful in cases, when in the time series there are significant differences in the data, as well as in cases, where the goods are cheap or perishable.
The advantage of the method of exponential smoothing with short-term forecasting consists mainly in the fact that it is quite simple and easy to use compared to other methods. In addition, the exponential smoothing forecast provides rapid response to all events that take place over a period that allows building the so-called “adaptive predictive model”. Such a model much better considers random variability of the function than trend model. Nevertheless, demand forecasting by exponential smoothing method will be more accurate if the determinants of demand are not subject to sharp fluctuations.
When using exponential smoothing, later data is given more attention than the earlier data. This method provides a quick forecast one period ahead, while automatically correcting any forecast concerning difference between actual and predicted results.
Smoothing constant is selected from 0 to 1. The value of the constant depends on the specific data. If a value close to 0, it means that the forecast for the next period will mainly depend on historical data, to a much lesser extent in view of recent evidence. If the value of tends to 1, then the prognosis largely affects the actual demand in the current period than historical data.
- Using suitable diagrams, explain how the strategic stockholding decoupling point in a leagile supply chain protects operations upstream of this point from demand amplification. What are the benefits of being protected?
The piece of the supply chain towards that meets the consumer offers and the piece of the supply chain derived from planning is divided by the decoupling point. The decoupling point also operates as the strategic stockholding point between variable consumer offers and product diversity and smooth production output. On the downstream of the decoupling point is an extremely changeable demand from the consumer side for high diversity, while on the upstream of the decoupling point the demand is smooth with the diversity decreased. The diagram below shows the application of lean paradigm towards the upstream of the decoupling point and the agile paradigm application towards the downstream from the decoupling point where demand is variable and the product variety per value stream is high.
Irregular market demand will (if all other things remain stable) have an upstream effect on the location of the DP, while short delivery times will force the DP more downwards, towards the make-to-stock position.
- If a supply chain became faster, what change to the position of the decoupling point would this allow in principle and what advantages would this give?
The suitable position of decoupling points is defined by the modification of companies’ approach from taking personal and exacting measures toward collaboration and attaining ordinary, inter-organizational objectives. Though, the character of cooperation in supply chains may differ depending on decoupling zones. If the organization framework is determined by a high level of significance of the price of assets to the total price, and/or as the exceptional value offer is designed at low price, the high use of assets is authorized. Therefore, the position of the decoupling point should be latterly of the alteration process, or as a minimum at the output point for the most applicable developed asset in terms of price.
Question 4
- Explain why vertical integration upstream in a supply chain is seen as a defensive move whilst vertical integration downstream is seen as an offensive move. For each direction, give an example of a business that has done this and explain why it has done it.
When a company seeks to unite or to establish vertical control of the firm in the later stages of the process chain, the integration is carried upstream. On the contrary, the integration downstream takes place where the company’s expansion is directed toward the sources of raw materials. Therefore, the vertical type of integration depends on at what point in the manufacturing process the firm is, which initiates the process.
When a company already dominates in one or more stages of production, vertical integration can cause a variety of anti-competitive effects. Integration downstream can assure the market, but also close it for competitors. Similarly, the integration upstream can guarantee sources of resources’ supply, but to block access to these sources for competitors. Moreover, if a firm buys a company – a supplier of rare raw materials, which is used by the firm and its competitors, in this case, it can take advantage of the position and to hold the price compression, i. e. to reduce the specific gross margins of its competitors by setting higher cost for them on raw material, at the same time maintaining a relatively low cost on the final product. Such tactics not only serves as a means of influencing the existing competitors, but also acts as a barrier to entry for potential new competitors. Lack of access to markets or sources of raw materials, as well as access on unfavorable terms, requires from potential competitors the same degree of integration as that of the existing firms. In this situation, the need for a large initial capital hinders such a large-scale entry into the market.
If, for example, imagine all the way to the consumer of a product, such as gasoline, as a vertical line, the integration upstream will fit connection of the oil extraction to the oil refining company (defensive move), downstream – the organization of its own network of petrol stations (offensive move because it facilitates the company to enlarge its control regarding consumers). Thus, ExxonMobil, the largest US and international oil company, has integration upstream including ExxonMobil Development Company, ExxonMobil Production Company, ExxonMobil Gas and Power Marketing Company, etc. Its integration downstream concerns Sea River Maritime, ExxonMobil Refining and Supply Company, ExxonMobil Fuels, Lubricants & Specialties Marketing Company, etc.
- Explain what is meant by economies of scale and why this is a major consideration when making vertical integration decisions.
Economies of scale are the reduction in the average cost of production and, therefore, unit costs by increasing production volumes. Economies of scale allow the manufacturers to offer their products at more competitive prices and thus capture a larger market share. When making vertical integration decisions, economies of scale is a major consideration, because integration downstream leads to lower costs, while the desired output is so great that provides the economies of scale as of suppliers, or if suppliers are more efficient and have the opportunity to improve their performance. Integration in the direction of suppliers has significant advantages, when they have significant profits, while supplied components occupy the major part of the cost of the final product, when necessary technological skills are easy to be learnt.
- Joint learning by supplier and customer can occur when a partnership is formed. Describe important examples of this joint learning and why it is valuable.
Partnership is the relationship between an organization-supplier and organization-customer suggesting that both sides recognize them as partners, with the main goal of both sides – the sharing of benefits from improving the efficiency and productivity of joint commitments undertaken in the framework of the relationship. The benefits of the joint learning between customers and suppliers include lower transaction costs; guarantee of security of supply; better coordination of suppliers and customers and more reliable barriers to the penetration of outsiders on the market.
Cooperation of this type between buyers and suppliers can put on in different forms, such as the establishment of long-term contractual obligations, disclosure of confidential information, the adaptation processes of production, delivery, and purchase to the requirements and needs as one who sells and the one who buys it. Intent and purpose of the partnership is to increase the efficiency of the creation system of value added. Choosing a partnership strategy, it is necessary to carefully weigh the benefits and costs of cooperation with the partner, taking into account the fact that the partnership can have both positive and negative sides. In relationships that are not updated and reinterpreted, social contacts between workers turn into friendships, and at some point simple tastes and a willingness to forgive one another misstep turns into economic inefficiency of the partnership.
For example, many functions of the business process can be sent to suppliers. There are cases, when the company transferred its preferred suppliers the function of inventory management and delivery of the goods. In this scheme provider independently monitored the trade balances of the company by its products, forecasted its demand and within existing requirements on the structure of inventory took the decision to supply products. For the qualitative performance of these functions, the supplier receives from the company additional benefits and long-term guarantees for the supply of its products.
Currently, there is an integration of business processes of the company with the processes of its clients. For example, the companies-distributors of pharmaceuticals implemented automated integration with pharmacies, which are their customers. Using specialized software, pharmacies make the purchase order, which automatically enters the company and is promptly executed. This integration significantly reduces the time, cost and quality of execution of the business process for handling requests of pharmacies.
- When would a buyer seek to leverage market uncertainty and what does this mean?
Market generates significant income differentiation and stratification of the population. But because the goods in a market economy are sent, where there is more money, the market may prescribe some people starve because of insufficient income, and others – receive excessive profits and stay in luxury. For example, inflation is one of the consequences of market uncertainty. In this case, even senior citizens can get extra income from rising prices, so they leverage market uncertainty (in so far as the increase in interest rates during periods of moderate inflation usually contributes to profitability of investments in bonds and money markets, as well as investing in stocks and residential real estate is becoming more profitable in the controlled inflation).
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