Chapter 11- Managing Economies of Scale in a Supply Chain Cycle Inventory

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Questions and Answers

What is the definition of cycle inventory in a supply chain?

The average inventory held in a supply chain due to the ordering of quantities that are less than the demand of the customer.

The minimum inventory held in a supply chain over a period of time.

The inventory held in a supply chain due to the ordering of quantities that are greater than the demand of the customer. (correct)

The maximum inventory held in a supply chain over a period of time.

Which of the following is NOT considered a fixed cost related to lot sizing for a single product?

Annual demand of the product (correct)

Fixed cost incurred per order

Cost per unit

Holding cost per year as a fraction of product cost

What is the formula for calculating the cost of equity?

Rf - β * (Rb + MRP)

Rf + β * (Rb - MRP)

Rf - β * (MRP - Rb)

Rf + β * (MRP - Rb) (correct)

Which of the following is NOT considered as a cost component of inventory holding cost?

Ordering cost (B) Signup and view all the answers

What is the definition of replenishment lead time?

The time it takes to receive an order from a supplier, once the order is placed. (D) Signup and view all the answers

Which of the following is an assumption made in estimating cycle inventory related costs?

Replenishment lead time is fixed. (A) Signup and view all the answers

Which of the following is NOT a factor considered in calculating ordering cost?

Holding cost per year as a fraction of product cost (D) Signup and view all the answers

What are the two main reasons why quantity discounts can increase the supply chain surplus?

Improved coordination to increase total supply chain profits and extraction of surplus through price discrimination. (B) Signup and view all the answers

What is a two-part tariff, and how does it work?

A pricing scheme where the manufacturer charges a fixed fee for the right to purchase the product and then charges a variable price per unit sold. (B) Signup and view all the answers

What does a volume-based discount scheme aim to achieve?

Induce retailers to purchase and sell the quantity that would be sold when the manufacturer and retailer coordinate their actions. (C) Signup and view all the answers

Which of these statements accurately describes a key difference between lot size-based discounts and volume-based discounts?

Lot size-based discounts encourage smaller order quantities, which reduces holding costs, while volume-based discounts incentivize larger purchases, potentially increasing holding costs. (C) Signup and view all the answers

What is the 'hockey stick phenomenon' in relation to volume-based discounts?

The trend where retailers increase the size of their orders toward the end of the evaluation period, attempting to maximize their benefits from the volume-based discount. (D) Signup and view all the answers

How does price discrimination, as used in quantity discounts, help maximize supplier profits?

It allows suppliers to charge different prices based on the amount purchased, maximizing revenue from customers with higher willingness to pay. (D) Signup and view all the answers

What are the key goals of trade promotions in the context of quantity discounts?

To incentivize retailers to use price discounts, displays, or advertising to stimulate sales and shift inventory from the manufacturer to the retailer and customer, ultimately defending the brand against competition. (A) Signup and view all the answers

What are the two primary options for retailers when dealing with trade promotions?

To pass through some or all of the promotion to customers to spur sales or to pass through very little of the promotion but purchase in greater quantity during the promotion period to exploit the temporary reduction in price (forward buy). (A) Signup and view all the answers

Why do trade promotions generally increase cycle inventory in a supply chain?

Trade promotions encourage retailers to purchase more, leading to higher inventory levels for the manufacturer, retailer, and customer. (C) Signup and view all the answers

What are some countermeasures to the negative impact of trade promotions on cycle inventory?

EDLP (every day low pricing) avoids frequent price fluctuations, and discounts are applied to items sold to customers (sell-through), not the quantity purchased (sell-in). Scanner-based promotions enable tracking and managing the impact of promotions on sales, offering more control. (C) Signup and view all the answers

In which situations might trade promotions still make sense?

Trade promotions might still be a viable strategy in situations where deal elasticity and holding costs are high, with strong brands, or as a competitive response. The effectiveness of these promotions needs to be carefully considered for each specific situation. (C) Signup and view all the answers

What does aggregating multiple products in a single order aim to achieve?

Aggregating multiple products in a single order simplifies the order process and reduces the number of deliveries. This can also lead to savings in transportation costs. (D) Signup and view all the answers

What are the potential benefits of aggregating multiple products in a single order?

Aggregating multiple products in a single order can lead to savings in transportation costs, reduced fixed cost for each product, smaller lot sizes for each product, and reduced cycle inventory. This results in a more efficient and cost-effective supply chain. (D) Signup and view all the answers

How does aggregating multiple products in a single order help reduce cycle inventory?

It reduces the number of deliveries required, leading to less time spent waiting for shipments and, therefore, less inventory needed. (D) Signup and view all the answers

What is the main difference between an all-unit quantity discount and a marginal unit quantity discount?

An all-unit quantity discount applies to all units purchased, while a marginal unit quantity discount applies to units purchased only above a certain threshold. This difference significantly affects how the discount is calculated and how it impacts purchasing decisions. (B) Signup and view all the answers

What is the key problem with lot size-based discounts in terms of supply chain efficiency?

Lot size-based discounts encourage retailers to order larger quantities to maximize the discount, resulting in higher cycle inventory and reduced supply chain efficiency. Volume-based discounts are generally preferable for improving supply chain efficiency and minimizing inventory levels. (A) Signup and view all the answers

What is the main goal in managing multiechelon supply chains?

To reduce total costs by coordinating orders (A) Signup and view all the answers

Which factor is NOT mentioned as a driver for lot sizing decisions?

Quality of suppliers (D) Signup and view all the answers

In the integer replenishment policy, when a customer has a longer reorder interval than the supplier, what should be done?

Make the customer's interval an integer multiple of the supplier’s interval (C) Signup and view all the answers

What action is recommended if cycle inventory buildup is due to large lot sizes?

Decrease changeover times (D) Signup and view all the answers

Which approach is suggested to handle buildup caused by transportation?

Facilitate aggregation and coordinate orders (A) Signup and view all the answers

What technology is recommended to address issues with order placement and receiving?

Electronic order placement (D) Signup and view all the answers

Which of the following is NOT a method to limit forward buying in response to short-term discounts?

Increase the quantity purchased during sales (C) Signup and view all the answers

If a supplier's fixed costs are excessive, what action should be taken?

Reduce fixed costs (C) Signup and view all the answers

How should the replenishment intervals be set across the supply chain?

Synchronized to facilitate logistics (A) Signup and view all the answers

Which situation would indicate that an integer replenishment policy is most beneficial?

Cycle inventories are large and demand is predictable (D) Signup and view all the answers

Study Notes

Cycle Inventory in Supply Chains

Cycle inventory is the average inventory held in a supply chain due to production or purchases in lot sizes exceeding customer demand.
Lot size (Q) is the quantity produced or purchased at a time.
Demand (D) is the demand per unit time.

Economies of Scale and Lot Sizing

Economic Order Quantity (EOQ): A method for optimizing lot size for a single product. It minimizes annual material, ordering, and holding costs.
Factors considered in EOQ:
- Annual demand (D)
- Fixed cost per order (S)
- Cost per unit (C)
- Holding cost per year (h) as a fraction of product cost
Key assumptions for EOQ:
- Steady demand (D units per unit time).
- No shortages allowed.
- Fixed replenishment lead time.

Estimating Cycle Inventory Costs

Inventory Holding Cost: Involves various costs:
- Cost of capital (influenced by equity (E), debt (D), risk-free rate (Rf), firm's beta (β), market risk premium (MRP), borrowing rate (Rb), and tax rate (t)).
- Obsolescence/spoilage costs.
- Handling costs.
- Occupancy costs.
- Miscellaneous costs (theft, security, damage, tax, insurance).
Ordering Cost: Includes costs related to placing and receiving orders:
- Buyer time.
- Transportation costs.
- Receiving costs.
- Other related costs.

Aggregating Multiple Products

Combining multiple products in a single order can reduce transportation and receiving costs, thus lowering cycle inventory.
This may involve a single delivery from multiple suppliers or a single truck delivering to multiple retailers.

Quantity Discounts

Lot size-based discounts: Discounts based on the quantity ordered in a single lot.
Volume-based discounts: Discounts based on the total quantity purchased over a given period.
All-unit quantity discounts.
Marginal unit quantity discount / multi-block tariffs.
Quantity discounts can improve coordination, increasing total supply chain profits. They can also extract surplus through price discrimination.

Two-Part Tariff

A pricing scheme where a manufacturer charges a fixed upfront fee (franchise fee).
This scheme can maximize coordinated supply chain profit.

Volume-Based Discounts

Schemes aim to achieve optimal quantity purchased by retailers.

Lessons from Discounting Schemes

Volume-based discounts are beneficial for reducing inventory and improving coordination.
Retailers often buy more toward the end of a promotional period, a "hockey stick" phenomenon.
Average prices for the retailers may decrease with increased purchase rates.

Price Discrimination

Setting different prices for different units based on marginal willingness to pay maximizes profit for the manufacturer.
Quantity discounts are a common price discrimination mechanism.

Trade Promotions

Short-term price discounts for a limited time to induce retailer sales efforts.
Goals include: boosting sales, shifting inventory, and defending against competitors.
Retailers may:
- Pass through discounts to customers.
- Purchase in large quantities (forward buying).
Trade promotions can increase cycle inventory and negatively impact performance. Strategies to counter that include:
- EDLP (everyday low pricing).
- Discounts linked to customer sell-through, not retailer buy-in.
- Scanner-based promotions.

Managing Multiechelon Cycle Inventory

Multiechelon supply chains have multiple stages with many players. Poor coordination in lot sizing increases cycle inventory.
Coordination across the supply chain can reduce overall costs.

Integer Replenishment Policy

A system for synchronizing reorders within a supply chain stage and across stages using integer multiples of reorder intervals.
This policy works best for predictable demand and high initial cycle inventory.

Managerial Levers for Reducing Cycle Inventory

Lot sizing decisions are driven by:
- Fixed costs.
- Quantity discounts.
- Short-term discounts.
Methods for reducing cycle inventory include:
- Reducing fixed costs, changeover times, coordinating orders, using aggregation points (e.g., milk runs).
- Employing appropriate technologies like electronic order placement, advanced shipping notices, and RFID.
Tactics for handling short-term discounts:
- Limiting forward buys.
- EDLP.
- Linking discounts to customer sell-through, not sell-in.
- Limiting quantity purchased.

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Description

This quiz explores the concepts of cycle inventory, economies of scale, and lot sizing in supply chain management. It covers the Economic Order Quantity (EOQ) method and the costs associated with holding inventory. Test your understanding of the factors influencing inventory management and optimization strategies.