HAMPTONSHIRE EXPRESS

Rajiv Misra
 PROBLEM 1

1. This is a Classic Newsvendor Problem

2. These problems identify the OPTIMAL stocking quantity for a perishable
product with unpredictable demand
3. Single stocking decision must be made prior to observing demand (ie no
replenishment – books, clothes)
4. This is the basis for Yield Management and Safety Stock calculations
5. This is an INTEGRATED supply Chain as Sheen publishes and retails
herself (no retailer)

Rajiv Misra
 PROBLEM 1 a
Use the Excel file to Simulate

• Use the given excel file and try out different combinations.
• Plot the values of fill rate and profits with respect to Stocking Quantity
• Fill Rate is the expected fraction of demand that Sheen can satisfy from
inventory

Use this Excel File

Rajiv Misra
PROBLEM 1 a

584

Rajiv Misra
 PROBLEM 1 a

1. Optimal Quantity is 584 units

2. It is not equal to the mean demand of 500, because the Cost of
overstocking is not equal to the cost of under stocking

3. Cu = Selling Price – Printing Cost = $1 - $0.2 = $ 0.8

4. Co = Printing Cost = $0.2

5. Fill Rate increases (expected fraction of demand that Sheen can satisfy
from inventory) increases as Sheen stocks more

Rajiv Misra
 PROBLEM 1 b
Using the NewVendor model

• Let us use the Newsvendor solution to solve this problem

• Critical Ratio works out as Cu/Co+Cu

Where Cu = Cost of under stocking = r-c = $ 0.8

Co = Cost of overstocking = c-s = $ 0.2
r = Unit Revenue = $1
c = Cost = $0.2
s = Salvage Value = 0

• Critical Ratio works out to (r-c) / (r-c +c –s) = r-c/r-s = 0.8/0.8+0.2 = 0.8
Use this Excel File
Rajiv Misra
 PROBLEM 1 b
3.00

(z)= 0.8 (z)

Q * 
 z where  ( z )  Cu / Co  Cu 0.00


1 7 13 19 25 31 37 43 49 55 61 67 73 79 85 91 97 103 109 115 121 127 133 139 145 151 157

0 z

Q*    z

• Let us use the Newsvendor solution to solve this problem

• z from Standard Normal tables works out to be 0.84
• Hence Optimal Stocking Qty = 500 + 0.84*100 = 584

Excel Command NORMSDIST(z) to find out area under Normal curve/ NORMSINV(Prob) to get z value Rajiv Misra
PROBLEM 2

Rajiv Misra
 PROBLEM 2

• This problem differs from Problem 1 because Sheen can alter the demand
of the product by investing in effort to improve the quality
• There is a relationship between channel effort and product demand.
Channel members can increase demand by advertising, R and D etc

Rajiv Misra
 PROBLEM 2

1. Use the excel file for this problem to determine the number of hours that
she should work to maximize her profits

Use this Excel File

Rajiv Misra
 PROBLEM 2

1. The opportunity cost stems from the fact that Sheen could have ‘fun’ in
the time she spends on the paper.
2. Sheen should work hard enough to equate the marginal cost of additional
effort ($10 per hour) with the marginal benefit of additional effort.
3. This is obtained by finding out the slope of the equation D = 500 + 50 h½
by differentiating with respect to h
4. The marginal effort of benefit is (50) / (2 * h½)
5. This slope is the marginal benefit in demand, the value of which is
obtained by multiplying with $0.8 earned by each paper sold more
(0.8 * 50) / (2 * h½)
6. Equating the slope of cost of additional effort which is $10 we obtain the
equation below

7. (0.8 * 50) / (2 * h½) = 10, we will get h = 4 hours Rajiv Misra

PROBLEM 3

Rajiv Misra
 PROBLEM 3

1. This problem differs from the previous two problems because we now
have a differentiated channel.
2. Sheen, the publisher, determines how hard she should work
3. Armentout determines the stocking quantity based partially on Sheen’s
effort.
4. Sheen and Armentout make their decisions independently.
5. In this case Armentout can ‘observe’ Sheen’s effort, while is many
channels ‘effort’ or ‘quality’ are uncontractable (i.e a third party cannot
verify the effort invested by individuals)

Rajiv Misra
 PROBLEM 3 a

1. Assuming h = 4, what is the optimal Stocking quantity that maximizes

Ralph Armentout’s profits.
2. Vary Q while holding h =4

Use this Excel File

Rajiv Misra
 PROBLEM 3 a

516

Use this Excel File

1. The optimal Stocking quantity that maximizes Ralph Armentout’s profits

is 516
Rajiv Misra
 PROBLEM 3 b
Why does the optimal differ?

Rajiv Misra
 PROBLEM 3 b

1. Why does Ralph stock less (516) than the mean demand (600)
2. Note that the mean demand is not 500 now, but is (D = 500 + 50 h½). At h = 4,
Mean demand works out to be 600.

3. Cu = Cost of under stocking = r-c = $ 0.2 (in integrated channel it was 0.8)

Co = Cost of overstocking = c-s = $ 0.8 (in integrated channel it was 0.2)

4. Ralph’s overstocking cost is significantly higher than his cost of

understocking. Hence it is optimal for him to stock less than the mean

Rajiv Misra
 PROBLEM 3 b

Differentiated Integrated Channel

Channel
Optimal Qty 516 584
Fill Rate 86% 98%
Cost of Overstocking $0.8 $0.2
Cost of $0.2 $0.8
Understocking

1. The Splitting of margins between Sheen and Ralph results in lower fill rates

Rajiv Misra
 PROBLEM 3 b
Using the NewVendor model
• Let us use the Newsvendor solution to solve this problem
• Critical Ratio works out as Cu/Co+Cu

Where Cu = Cost of under stocking = r-c = $ 0.2

Co = Cost of overstocking = c-s = $ 0.8
r = Unit Revenue = $ 1
c = Cost = $ 0.8
s = Salvage Value = 0

• Critical Ratio works out to (r-c) / (r-c +c –s) = r-c/r-s = 0.2/0.2+0.8 = 0.2

Rajiv Misra
 PROBLEM 3 b
3.00

(z)= 0.2 (z)

Q * 
 z where  ( z )  Cu / Co  Cu 0.00


1 7 13 19 25 31 37 43 49 55 61 67 73 79 85 91 97 103 109 115 121 127 133 139 145 151 157

0 z

Q*    z

• Let us use the Newsvendor solution to solve this problem

• z from Standard Normal tables works out to be (-) 0.84
• Hence Optimal Stocking Qty = 600 - 0.84*100 = 516

Rajiv Misra
PROBLEM 3 c

Rajiv Misra
 PROBLEM 3 c

1. Use the Excel Sheet below to find out the optimal effort Sheen should put in
this differentiated channel.

Use this Excel File

Rajiv Misra
 PROBLEM 3 c

2.25

Use this Excel File

The optimal effort Sheen should put in this differentiated channel is 2.25 hours
Rajiv Misra
 PROBLEM 3 c

1. The optimal effort Sheen should put in this differentiated channel is 2.25
hours.
2. The optimal effort is lesser than 4 hours in the integrated channel due to
margins being split between her and Armentout and hence a lower value of h.
3. This can be solved as below
4. Marginal benefit per paper for Sheen is now $ 0.6 (Selling Price (0.8) less cost
(0.2)).

5. (0.6 * 50) / (2 * h½) = 10, we will get h = 2.25 hours

Rajiv Misra
PROBLEM 3 d

Rajiv Misra
 PROBLEM 3 d

1. The transfer price is now being changed from $ 0.8

2. Use the Excel sheet to find out the impact on Sheen’s effort level
3. Use the Excel sheet to find out the impact on Ralph’s stocking decision

Use this Excel File

Rajiv Misra
PROBLEM 3 d

Rajiv Misra
PROBLEM 4

Rajiv Misra
 PROBLEM 4

• This problem examines the situation where Armentout carries a private –

label product that offers him

• Higher Margins
• Lower obsolescence costs

Rajiv Misra
 PROBLEM 4 a

1. Use the Excel sheet to find out the optimal stocking quantity

Use this Excel File

Rajiv Misra
 PROBLEM 4 a

409

The quantity is significantly different from 584 calculated earlier

Rajiv Misra