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 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

Φ(z)= 0.8 Φ(z)

Q * −µ
= z where Φ ( z ) = Cu / Co + Cu 0.00

σ
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* = µ + zσ

• 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. 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 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

Φ(z)= 0.2 Φ(z)

Q * −µ
= z where Φ ( z ) = Cu / Co + Cu 0.00

σ
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* = µ + zσ

• 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

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

Rajiv Misra
 PROBLEM 3 d

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

2. By lowering the transfer price, we would increase Ralph’s benefit from
stocking a marginal unit (ie higher understocking cost).
3. This reduces Sheen’s gain and her incentive to work hard
4. Sheen’s profits are higher when transfer price is higher and vice versa for
Ralph.

Transfer Price = $0.7 Transfer Price = $0.35

Optimal Qty 510 557
Stocked by Ralph
Fill Rate 89% 96%
Sheen’s Effort 1.563 0.141

Rajiv Misra
 PROBLEM 3 d
Using the NewVendor model
Transfer Price = $0.70

• Let us use the Newsvendor solution to solve this problem

• Transfer Price = $ 0.7. Cost of paper = 0.2. Marginal benefit to Sheen is $
0.5
• h for Sheen will be (0.5 * 50) / (2 * h½) = 10, we will get h = 1.563
hours

• Note that the mean demand is not 500 now, but is (D = 500 + 50 h½). At
h = 1.563, Mean demand works out to be 563

Rajiv Misra
 PROBLEM 3 d
Using the NewVendor model
Transfer Price = $0.70
• For Ralph the figures are:
• Critical Ratio works out as Cu/Co+Cu
Where Cu = Cost of under stocking = r-c = $1 - $0.7 = $ 0.3
Co = Cost of overstocking = c-s = $ 0.7
r = Unit Revenue = $ 1
c = Cost = $ 0.7
s = Salvage Value = 0
• Critical Ratio works out to (r-c) / (r-c +c –s) = r-c/r-s = 0.3/0.3+0.7 = 0.3

Rajiv Misra
 PROBLEM 3 d: Transfer Price = $0.7
3.00

Φ(z)= 0.3 Φ(z)

Q * −µ
= z where Φ ( z ) = Cu / Co + Cu 0.00

σ
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* = µ + zσ

• Let us use the Newsvendor solution to solve this problem

• z from Standard Normal tables works out to be (-) 0.53
• Hence Optimal Stocking Qty = 563 - 0.53*100 = 510

Rajiv Misra
 PROBLEM 3 d
Using the NewVendor model
Transfer Price = $0.35

Rajiv Misra
 PROBLEM 3 d
Using the NewVendor model
Transfer Price = $0.35

• Let us use the Newsvendor solution to solve this problem

• Transfer Price = $ 0.35. Cost of paper = 0.2. Marginal benefit to Sheen is
$ 0.15
• h for Sheen will be (0.15 * 50) / (2 * h½) = 10, we will get h = 0.141
hours

• Note that the mean demand is not 500 now, but is (D = 500 + 50 h½). At
h = 1.563, Mean demand works out to be 519

Rajiv Misra
 PROBLEM 3 d
Using the NewVendor model
• For Ralph the figures are:
• Critical Ratio works out as Cu/Co+Cu
Where Cu = Cost of under stocking = r-c = $ 0.65
Co = Cost of overstocking = c-s = $ 0./35
r = Unit Revenue = $1
c = Cost = $0.35
s = Salvage Value = 0
• Critical Ratio works out to (r-c) / (r-c +c –s) = r-c/r-s = 0.65/0.65+0.35 = 0.65

Rajiv Misra
 PROBLEM 3 e

• Channel Effort and Stocking level are likely to be lower in a differentiated

channel than in an integrated one due to splitting of margins

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 b

Rajiv Misra
 PROBLEM 4 b

• The reason for this is that Ralph’s cost of under stocking on the Express is
significantly reduced due to the customer’s willingness to switch to the
Private.
• Cu = Cost of under stocking = $ 0.04. This is $0.20 (margin on
Express) less the expected marginal revenue from the sale of Private to
this customer.
• Private sells for $0.50. Cost is $0.10. Revenue is $0.40.
• Expected marginal revenue for Private = 40% of 0.40 = $0.16.
• Cu = Cost of under stocking = $ 0.20 - $ 0.16 = $ 0.04
• Co = Cost of overstocking = $ 0.80
• Comparing these costs predicts that Ralph will stock less than the mean

Rajiv Misra
 PROBLEM 4 b
Using the NewVendor model
• For Ralph the figures are:
• Critical Ratio works out as Cu/Co+Cu
Where Cu = Cost of under stocking = $ 0.04
Co = Cost of overstocking = $ 0.80

• Critical Ratio works out to be = 0.04/0.04+0.80 = 0.048

• Note that the mean demand is (D = 500 + 50 h½).

• At h = 2.25, Mean demand works out to be 575.

Rajiv Misra
 PROBLEM 4 b
Using the NewVendor model 3.00

Φ(z)= 0.048 Φ(z)

Q * −µ
= z where Φ ( z ) = Cu / Co + Cu 0.00

σ
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* = µ + zσ

• Let us use the Newsvendor solution to solve this problem

• z from Standard Normal tables works out to be - 1.66
• Hence Optimal Stocking Qty = 575 - 1.66*100 = 409

Rajiv Misra