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Standard Deviation and Minimum Order

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  • Category: Risk

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Sport Obermeyer started to make firm commitments for producing its 1993-1994 line of fashion skiwear with scant information about how the market would react to the line. Inaccurate forecasts of retailer demand had become a growing problem at Obermeyer: in recent years greater product variety and more intense competition had made accurate predictions increasingly difficult. Also, another issue Sport Obermeyer faced was how to allocate production between factories in Hong Kong and China. They need consider all aspects in a short-term period and also a long-term period.


1. Using the sample data given in Table 2-20, make a recommendation for how many units of each style Wally should make during the initial phase of production. Assume that all of the 10 styles in the sample problem are made in Hong Kong and that Wally’s initial production commitment must be at least 10,000 units. Ignore price differences among styles in your initial analysis.

In order to decide how many units of each style Wally should make, we should think about their order’s range, we ignore price differences among styles so we need to think about the maximum order and minimum order for each style. First of all, we need to calculate the stock out probability based on benefit percentage and risk percentage. According to the case, Obermeyer earned 24 percent of wholesale price on each parka it sold, and that units left unsold at the end of the season were sold at a loss that average 8 percent of wholesale price. Therefore, the stock out probability equal to 8%/(24%+8%)=25% so there are 75% probability of being less than mean+0.67*SD (standard deviation). According to z table, z equal to 0.67 when probability is 0.75. Therefore, we can calculate quantity for each style include the risk of stock out by using formulate Q*=mean+z*SD. Therefore, we can get the maximum order units for each style in order to avoid stock out.

Because initial production commitment must be at least 10,000 units, therefore, we also need to calculate the minimum order for each style. Figure 2 shows we calculate the minimum order by using formula Q*=average-2*SD. Because we assume that all of the 10 styles in the sample are made in Hong Kong and there is a minimum production quantity 600 units so we changed all less than 600 units to 600. Then we can get the total

2. Can you come up with a measure of risk associated with your ordering policy? This measure should be quantifiable.

Forecast is always wrong. This ordering policy associates with many kinds of risks such as inventory holding cost, uncertain demand and so on. We can calculate the coefficient of variation for each style in order to measure risks by using 2*standard deviation/average because the coefficient of variation measures variability relative to average demand. Then, we can get the average of coefficient of variation which is 0.51. We compared the average of coefficient of variation and the coefficient of variation of each style. If the number is greater than 1, which means risk of this style is higher than average. The company should product lower risk factors’ style in the initial production.

We can find that the risk factor of Assault (0.53), Seduced (0.54), Entice (0.72), Electra (0.74) are lower than others. Therefore, they do better to produce more units of those lower risk factor styles in the initial production.

3. Repeat your methodology and assume now that all 10 styles are made in China. What is the difference (if any) between the two initial production commitments?

Because there is different minimum order quantity between Hong Kong (600) and China (1200), therefore, the order units should be different. The minimum order in China is much greater than Hong Kong so we should consider inventory holding costs, lead time and all factors into the decision. I recommend Obermeyer should only produce those styles which have a lower risk factor due to the large number of minimum quantity. Figure 4 shows us that we should produce Gail (1200), Entice (1200), Assault (1845), Electra (1343), Seduced (2904), Anita (1202) and Daphne (1200) in the initial production.

4. What operational changes would you recommend to Wally to improve performance?

For the design process, according to the case, Obermeyer usually received orders representing 80 percent of its annual volume by the week following the Las Vegas show. They can show samples and offer some promotions to all retailers before Las Vegas show in order to get more accurate data for demand. They may better do demand forecast for each styles instead of forecasting the total demand. For supply chain, according to the case, the preparation of each such ‘lab-dip’ took two weeks; the procedure at times had to be repeated if the quality of the lab-dip was not found to be satisfactory by Obermeyer managers or designs. They could use information technology to do some designs on computer in order to save some times. They could use more flexible materials in order to use those materials for more styles especial zippers. For cut and sew process, they should produce those styles which have larger units and lower risk in China and those styles which have smaller units and higher risk in Hong Kong. Also, they should provide more training to Chinese workers in order to improve efficiency.

5. How should Wally think (both short-term and long-term) about sourcing in Hong Kong versus China? What kind of sourcing policy do you recommend?

Compare Hong Kong with China, workers in Hong Kong worked about 50 percent faster than their Chinese counterparts. Hong Kong workers are typically trained in a broader range of tasks. Wages in China were much lower than in Hong Kong; an average sewer in a Guangdong sewing factory earned US$0.16 per hour compare with US$3.84 per hour in the Alpine factory in Hong Kong. The minimum order in Hong Kong is 600 units and the minimum order in China is 1200 units. Therefore, for short-term, in the initial production period, Obermeyer should produce those styles which have a lower risk factor and large units in China because the lower labor cost, longer lead time and quota restrictions in China. They may choose Hong Kong for those styles which have higher risk factors and small units in second and finial production period in order to get their products faster.

For long-term period, they may move more production lines from Hong Kong to China because the labor cost is lower and there is larger capacity to produce. According to the case, Raymond decided to build a larger factory in Guangdong, China so the conditions of production lines are better in China. On the other hand, China is another potential market so in the future Obermeyer can expand their market in China. When they increase their sales, minimum orders will become a smaller problem.

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