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Mitigating Demand Uncertainty Across A Winery's Sales Channels Through Postponement
Mitigating Demand Uncertainty Across A Winery's Sales Channels Through Postponement
C
I S
(4)
The model assumes that no inventory from the prior year remains and all of that
years production is sold with a year. While starting and ending inventories are important
considerations for other industries, they have less relevance in wine production. Most
wineries make vintage-dated products, such as 2004 Merlot, and do not blend in wine
from earlier years. Wineries have limited storage capacities, especially at intermediate
inventory points such as tanks, which must be emptied before the next years harvest can
be processed. Wine is a high value product and is expensive to keep long term. Therefore,
we can treat the yearly production and sales cycle as a single period model. Swaminathan
and Tayurs study (1998) suggests that results would differ little if the additional
complexity of multiple periods were included.
The last three types of variables relate directly to market conditions: xf
c,s
, sales of
product at full price, xs
c,s
, sales at salvage value, and xv
c,s
, any demand shortfall
(violation) for each sales channel. Equation (5) ensures that no more finished goods are
sold at full price than were demanded in the channel:
, ,
,
c s c s
xf D c s s e e C S
(5)
Conversely, minimum demand requirements are represented in equation (6) by
allowing the winery to under-deliver to demand, but recording the shortfall:
, , ,
- ,
c s c s c s
xv D xf c s s e e C S
(6)
The model currently assigns non-zero fees only for shortfalls of private label products, as
these are likely to be subject to stricter contracts. A winery experiencing an unexpected
demand surge across multiple channels may thus need to devote more wine to a private
label product, even though it likely has lower margins than the winerys own brand.
Wine in each finished goods channel will either be sold at full price, R
c
, or at
salvage value, S
c
. Aside from tarnishing brand perception, salvaging wine is undesirable
because lower revenues are earned. Private label wines bear another companys brand,
preventing a winery from receiving a non-zero salvage price. The final balance equation
(7) guarantees that all wine that is either initially finished or later transformed is then
sold. Excess channel supply must become salvage and cannot be repackaged or
repurposed to different channels:
, , , ,
,
c i c s c s c s
i
xp xt xf xs c s
e
+ = + e e
I
C S
(7)
The objective is to maximise expected profits across all channels. While the
objective function (8) may appear complex, it can be broken down into component cost
and revenue terms. Deterministic costs include the production cost, G, and packaging
costs, L
c,
of the initial allocation of finished goods and production cost and storage costs,
W
i
, for intermediate goods. All other terms involve the dimension of demand scenario.
These include the costs associated with transforming intermediate inventories into the
desired finished goods, necessitating labelling/packaging costs, supplemented by the
additional costs, A
i,c
, associated with postponement. Revenues are collected from multiple
sources: the sale of finished goods at full price and at salvage value. Product that is
dumped before being finished may receive a subsidy, B
i
, although current research
focuses on US wineries, and we have set this term to zero. Violations are assessed fees,
F
c
, in channels where demand shortfalls are considered a breach of contract.
8
( )
( ) ( )
( )
, , , ,
, , ,
max
+
s
c c s c c s c c s i i s
s c i
c c i i
c i
s
i c c i c s
s c i
P R xf S xs F xv B xd
L G xp W G xi
P A L xt
e e e
e e
e e e
| |
+ +
|
\ .
| |
+ +
|
\ .
+
S C I
C I
S C I
(8)
The use of discrete probability distributions allows this problem to be represented
as a deterministic equivalent linear program. The model is implemented in the GAMS
modelling environment utilising MINOS as the solver. With 4 finished goods channels, 2
intermediate inventory points and 7 demand scenarios, the model has 161 variables in
total: 6 first-stage variables and 154 recourse variables, in addition to z, the total expected
profit. The enumeration of all 6 types of constraints results in 156 equations. As the
model is linear, solution times are sub-second and not of concern.
4. Results
4.1. Quantifying the profitability from postponement
The focus of our research to date has been in constructing and validating the conceptual
model. Although we interviewed several winemakers to understand their use and
perceptions of postponement, we do not have definitive values for all of the model
parameters. Depending on size, marketing efforts, wine quality and other factors, each
winery will have different parameter values. Appendix A shows the numerical values
used and indicates where validation has occurred or what the rational is for certain
values. For instance, channel revenues and costs have been structured so that the per-case
cost and profit margins of the branded channel are the highest, followed in decreasing
order by both Private Label products and bulk sales.
Even the use of placeholder data provides results worth studying. While most of
the decision variables are recourse variables, these are of less interest because
determining which products to finish and what revenues can be obtained is
straightforward once channel demands are known. The variables to examine are those
determined in the first stage; these control the degree and type of postponement used.
Figure 3 shows the optimal level for the first-stage variables for two different
situations: one where postponement is allowed and one where it is forbidden. When
postponement is allowed, it is optimal to delay the final finishing of 25% of the total
production, with two-thirds of this intermediate inventory allocated to the tanks. Without
postponement we would instead: 1) bottle more Private Label A, and risk oversupply
without any revenues from channel excess if demand were low and 2) sell more bulk
wine, sacrificing the revenues that would be earned in profitable channels were demand
higher. The potential value of postponement can be quantified by comparing optimised
expected profits from when postponement is allowed to when postponement is forbidden.
The use of postponement gives our hypothetical winery an expected increase in product
profitability of 8%, a considerable improvement.
9
4.2. Additional situational analysis: sensitivity of results to probability assumptions
The reader may question why we have selected the particular probability
distribution for the seven scenarios. Scenario probabilities are one of the least qualified
parameters in the model and are not easy to validate. To address this concern, we define
three additional situations, changing the probability distribution of the demand scenarios,
as shown in figure 4. For example, the Expect high demand situation assigns a greater
chance of larger demands on some or all of the channels, although still allowing a slight
possibility for channel demands to be low.
Optimisation results from these additional situations were compared to those from
the standard situation. Figure 5 shows that both packaging and labelling postponement
occur in all 4 situations. The differences are in the amount allocated to each of the
finished goods channels and intermediate inventory points. If the lower demand scenarios
have a greater likelihood, more postponement would be utilised; the fraction of
production allocated to intermediate inventory increases from 25% to 33% from the
standard situation to that of Expect low demand. Postponement usage did not decrease
in Expect high demand, but initial allocations changed from a guaranteed sale in the
bulk channel to a higher-margin but riskier channel, Private Label B.
Another result seen in figure 5 is that the usage of postponement should increase
when the producer has even less of an idea of what demand is likely to be. The uncertain
situation considers all scenarios equally likely and results in 42% of production being
held as intermediate inventory, the majority in tanks, which provide even more versatility
than blanks for transformation into finished goods.
We can extend these results to make additional conclusions. If channel demands
are less correlated than assumed, and scenarios such as simultaneous low demand for
Private Label A and high demand for Private Label B are considered to be possible or
even likely, benefits from postponement can only increase. Use of postponement to
manage product differentiation is analogous to using risk pooling to manage safety
inventory, and Chopra and Meindl (2004) show that products with lower demand
correlation will experience even greater savings from aggregation techniques.
4.3. Model results compared with practice
We interviewed operations managers at four US wineries of different sizes to compare
our theoretical results with actual industry practices. Interviews were difficult to procure
as most wineries are private firms concerned with maintaining their competitive
advantage, not to mention the consumers perceptions that wine is an artesian product.
They were reluctant to divulge operation details, and two asked to remain anonymous.
One of the unidentified wineries is a very large producer that supplies wines
within a wide price range from several regions, but primarily from Californias Central
Valley. Intermediate inventory is stored as blanks, as it can be used to source two
different product lines, both of which are brands owned by the winery. This process is
estimated to increase costs by approximately $1 per case and is only used for an
unspecified fraction of the two brands total production. No instances of postponement at
the tank level were identified.
10
The JanKris winery in Paso Robles produces 25,000 cases annually of premium
wines priced between $7 to $14 per bottle. This winery has been growing for the past few
years and has actively expanded their product line, including blending a private label
wine for a large client. JanKris stores inventory in both the blank and tank phase to
allocate to different products as needed.
A small, unnamed boutique winery in Napa Valley produces 5000 cases a year of
wines priced above $14 per bottle. Before 1999, this winery would defer the labelling of
a significant part of their annual production because they were uncertain whether they
would be able to sell everything under their own label. However, they have since
discontinued this practice as demand has increased, effectively guaranteeing that they can
sell all their wine upon release.
The sole winery in this group of four that has never used postponement is Pine
Ridge. This Napa Valley winery produces 50,000 cases annually of wine priced above
$14 per bottle. Pine Ridges operations manager claims that deferring bottling has the
potential to decrease wine quality. It should be noted that Pine Ridge does not offer any
private label products and thus would benefit little from postponement.
Although far from an exhaustive survey, these interviews help to confirm results
from the theoretical model. Postponement is of less value to wineries that sell through a
single sales channel and that have consistent, high demand for their products. But for
wineries that do not have the luxury of being in this market position and for those that are
large or offer multiple product lines, postponement strategies can be useful. We found
more instances of postponement further downstream, at the labelling level, than at the
packaging level. Our model conversely favours more usage of tanks than blanks, but we
would be remiss to draw further conclusions without more data points.
4.4. Suggestions for future research
Foremost, additional research should include surveying more winemakers. We believe it
would also be illuminating to compare postponement practices in different countries.
European wineries may utilise postponement more as their greater emphasis on exporting
necessitates specific labels for many markets. Additionally, European markets sell more
store-branded wines, so local wineries are also more likely to source private label
products. With both the practice of exporting and the presence of private label wines
expected to increase in the US, it behoves American wineries to study the best practices
of their peers abroad.
Another valuable effort would be to perform in-depth case studies of different
wineries. Optimising the model using parameters, scenarios, and probabilities that have
been provided by a specific winery would provide a customised postponement strategy.
We could then compare results from different wineries to find more robust estimates for
standard model parameters, validate model assumptions, and ultimately better quantify
the potential of postponement across the industry as a whole.
For wineries that offer both blended and single varietal wines, a possible model
extension would consider optimising the components of the blends based on evolving
demands. Wineries often grow their own grapes or enter into long term purchasing
contracts, so varietal (type of grape) supply availability typically changes more slowly
than consumer trends. Recipes for blended wines could be adjusted to use more of the
11
less desired grapes varieties, saving the popular ones for sale as single varietal wines.
This extension would allow the use of a third type of form postponement: that of
assembly.
5. Conclusion
US wineries face an increasingly competitive, globalised marketplace. Many can no
longer expect to sell all the wine they produce under their own brand. As private label
wines gain popularity, more wineries will become sources and must determine how to
allocate production across sales channels. Producers who can achieve this balance
through techniques such as postponement will be at a competitive advantage.
Our stochastic programming model demonstrates that using form postponement at
the packaging and labelling stages can increase expected profits. Our hypothetical winery
had an 8% expected improvement in product profitability by postponing the finishing of
25% of production. What-if analysis shows that postponement usage increases if demand
is more likely to be lower or if wineries are unable to estimate channel demand
probabilities.
The competitive advantage of using postponement has still to be better qualified.
As every winery has different supply and demand characteristics, the optimal
postponement strategy will not be uniform across the industry. We recommend
performing case studies for a few wineries. We also suggest investigating postponement
practices of more wineries from around the globe and extending the model to optimise
the recipes of blended wines.
12
Appendix A: Model Parameters
Cost and Production Parameters
C Total annual case production 12000
G
Pre-bottling cost of producing wine
per case
30 $
L
c
brand 18 $
pl-a 12 $
pl-b 9 $
bulk - $
W
i
tanks 1 $
blanks 4 $
A
i,c
tanks blanks
brand 8 $ (1) $
pl-a 8 $ (1) $
pl-b 7 $ - $
bulk - $ - $
T
i,c
tanks blanks
brand 1 1
pl-a 1 1
pl-b 1 0
bulk 1 0
Demand and Pricing Parameters
R
c
brand 78 $
pl-a 54 $
pl-b 45 $
bulk 33 $
S
c
brand 36 $
pl-a - $
pl-b - $
bulk - $
F
c
brand - $
pl-a 10 $
pl-b 8 $
bulk - $
B
i
blanks - $
tanks - $
P
s
Probability of scenario s
D
c,s
Dem_base brand 5000
pl-a 2000
pl-b 2000
bulk 12000
Only branded wine has salvage value. These salvage values are
constructed so that products sell at a loss.
Per case full-price revenue by sales channel
Additional per case costs that come with the transformation of intermediate inventory i to sales channel c
The negative for "blanks" reflects the fact that bottling
(and its associated costs) will have already occurred.
Postponement will still be more expensive than initial
allocation, by $3 case more from blanks.
Subsidy (buy-back) for dumping wine at intermediate inventory points
Per case packaging and storage costs for intermediate inventory
The [0,1] matrix mapping the transformation of intermediate inventory i into finished goods for sales channel c
1 = a legal transformation
0 = a forbidden transformation
Revenues will vary with winery size and reputation, but are
structured so that they are higher for brand than private labels, and
that when costs are included, profit by case is highest for brand and
lowest for bulk.
Fees are structured so that only private label wines have fees, and
Private Label A has higher fees than Private Label B. These are per
unit fees, whether the shortage is 10 cases or 10000 cases
Per case fee for shorting demand by sales channel
Per case salvage value by sales channel
Production costs are highly variable, but Folwell and Castaldi (1987)
suggest an inflation adjusted $4-$5/bottle for medium wineries, net
of packaging and labelling
Represents a small winery
Costs are structured so that they are higher for brand than private
label. These costs are by definition zero for bulk wine
Tank costs are for storage. Blank costs are higher as they include
both the material and processing costs of bottling
Marketing, bottling and labeling cost per case equivalent, by channel
These values are shown in Figure 2
Per case demand across channels for scenarios: = P
s
*Dem_base, where Dem_base is below
Demand is structured so that Brand still repesents the primary
channel, but bulk wine is an unsaturated market. These parameters
were used to so that under many (but not all) demand scenarios, the
winery would have to sell to all 4 channels.
No subsidies are used at present, as U.S. wineries do not receive
payments for dumping.
13
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nd
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14
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15
Titles and Captions for Figures
Figure 1
Title: Overview of post-blending production
Caption: Arrows denote allowed transitions between stages in the process of
creating finished goods for all channels. Intermediate inventory points are
underlined.
Figure 2
Title: Demand scenarios: percentage of base demand by sales channel
Caption: Demands for the other six scenarios are referenced to the base
scenario.
Figure 3
Title: Allocation of production when postponement is allowed or forbidden
Caption: The first four categories represent the initial allocations to finished
products, and the last two show allocations to intermediate inventory points.
Figure 4
Title: Probability distributions for the different situations
Caption: While the situations have different probabilities for the scenarios, all
scenarios still have a possibility of occurring.
Figure 5
Title: Summary of first-stage decision variables by situation
Caption: Postponement utilisation is shown in the last two columns.
16
Figure 1
Tanked wine
Bottling
process
Bulk wine channel
Labeling
process
Blank
wine
Private
Label B
channel
Private
Label A
channel
Unlabeled
Pl-B brand
Branded
channel
17
Figure 2
0%
20%
40%
60%
80%
100%
120%
140%
160%
s1: base s2: high all s3: high
brand
s4: high PL s5: low all s6: low
brand
s7: low PL
brand
pl-a
pl-b
18
Figure 3
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
xp.brand xp.pl-a xp.pl-b xp.bulk xi.tanks xi.blanks
postponement
forbidden
postponement
allowed
19
Figure 4
0%
5%
10%
15%
20%
25%
30%
s1:
base
s2: high
all
s3: high
brand
s4: high
PL
s5: low
all
s6: low
brand
s7: low
PL
Standard
situation
Expect low
demand
Expect high
demand
Uncertain
situation
20
Figure 5
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Standard situation Expect low
demand
Expect high
demand
Uncertain
situation
xp.brand
xp.pl-a
xp.pl-b
xp.bulk
xi.tanks
xi.blanks