Sport Obermeyer Case

John H. Vande Vate

Spring, 2006

1
1
 Issues
• Question: What are the issues driving this
case?
– How to measure demand uncertainty from
disparate forecasts
– How to allocate production between the
factories in Hong Kong and China
• How much of each product to make in each factory

2
2
 Describe the Challenge
• Long lead times:
– It’s November ’92 and the company is starting
to make firm commitments for it’s ‘93 – 94
season.
• Little or no feedback from market
– First real signal at Vegas trade show in March
• Inaccurate forecasts
– Deep discounts
– Lost sales

3
3
 Production Options
• Hong Kong • Mainland (Guangdong, Lo Village)
– More expensive – Cheaper
– Smaller lot sizes – Larger lot sizes
– Faster – Slower
– More flexible – Less flexible

4
4
 The Product
• 5 “Genders”
– Price
– Type of skier
– Fashion quotient
• Example (Adult man)
– Fred (conservative, basic)
– Rex (rich, latest fabrics and technologies)
– Beige (hard core mountaineer, no-nonsense)
– Klausie (showy, latest fashions)
5
5
 The Product
• Gender
– Styles
– Colors
– Sizes
• Total Number of SKU’s: ~800

6
6
 Service
• Deliver matching collections
simultaneously
• Deliver early in the season

7
7
 The Process
– Design (February ’92)
– Prototypes (July ’92)
– Final Designs (September ’92)
– Sample Production, Fabric & Component orders (50%)
– Cut & Sew begins (February, ’93)
– Las Vegas show (March, ’93 80% of orders)
– SO places final orders with OL
– OL places orders for components
– Alpine & Subcons Cut & Sew
–
–
Transport to Seattle (June – July)
Quotas!
Retailers want full delivery prior to start of season (early
September ‘93)
– Replenishment orders from Retailers

8
8
 Quotas
• Force delivery earlier in the season
• Last man loses.

9
9
 The Critical Path of the SC
• Contract for Greige
• Production Plans set
• Dying and printing
• YKK Zippers

10
10
 Driving Issues
• Question: What are the issues driving this
case?
– How to measure demand uncertainty from
disparate forecasts
– How to allocate production between the
factories in Hong Kong and China
• How much of each product to make in each factory
• How are these questions related?

11
11
 Production Planning Example
• Rococo Parka
• Wholesale price $112.50
• Average profit 24%*112.50 = $27
• Average loss 8%*112.50 = $9

12
12
 Sample Problem
Individual Forecasts
Style Price Laura Carolyn Greg Wendy Tom Wally Average Std. Dev 2X Std Dev
Gail $ 110.00 900 1,000 900 1,300 800 1,200 1,017 194 388
Isis $ 99.00 800 700 1,000 1,600 950 1,200 1,042 323 646
Entice $ 80.00 1,200 1,600 1,500 1,550 950 1,350 1,358 248 496
Assault $ 90.00 2,500 1,900 2,700 2,450 2,800 2,800 2,525 340 680
Teri $ 123.00 800 900 1,000 1,100 950 1,850 1,100 381 762
Electra $ 173.00 2,500 1,900 1,900 2,800 1,800 2,000 2,150 404 807
Stephanie $ 133.00 600 900 1,000 1,100 950 2,125 1,113 524 1,048
Seduced $ 73.00 4,600 4,300 3,900 4,000 4,300 3,000 4,017 556 1,113
Anita $ 93.00 4,400 3,300 3,500 1,500 4,200 2,875 3,296 1047 2,094
Daphne $ 148.00 1,700 3,500 2,600 2,600 2,300 1,600 2,383 697 1,394
Total 20,000 20,000 20,000 20,000 20,000 20,000 20,000

Cut and Sew Capacity

3000 Units/month
7 month period

First Phase Commitment

10,000 units

Second Phase Commitment

10,000 units

13
13
 Recall the Newsvendor
• Ignoring all other constraints
recommended target stock out probability
is:
1-Profit/(Profit + Risk)
=8%/(24%+8%) = 25%

14
14
 Ignoring Constraints
Style Mean Std Dev Recommended Order Quantity
Gail 1,017 388 1,278
Isis 1,042 646 1,478 Everyone has a 25%
Entice 1,358 496 1,693
Assault 2,525 680 2,984 chance of stockout
Teri 1,100 762 1,614 Everyone orders
Electra 2,150 807 2,695
Stephanie 1,113 1048 1,819 Mean + 0.6745
Seduced 4,017 1113 4,767
Anita 3,296 2094 4,708
Daphne 2,383 1394 3,323
26,359 Note This suggests over buying!

P = .75 [from .24/(.24+.08)]

Probability of being less than
Mean + 0.6745 is 0.75 15
15
 Constraints
• Make at least 10,000 units in initial phase
• Minimum Order Quantities

16
16
 Objective for the “first 10K”
• First Order criteria:
Expected Profit
– Return on Investment:
Invested Capital

• Second Order criteria:

– Standard Deviation in Return

• Worry about First Order first

17
17
 First Order Objective
• Maximize  = Expected Profit
Invested Capital

• Can we exceed return *?

• Is
L(*) = Max Expected Profit - *Invested Capital >
0?

18
18
 First Order Objective
• Initially Ignore the prices we pay
• Treat every unit as though it costs Sport
Obermeyer $1
• Maximize  = Expected Profit
Number of Units Produced

• Can we achieve return ?

• L() = Max Expected Profit -  Qi > 0?

19
19
 Solving for Qi
• For  fixed, how to solve
L() = Maximize  Expected Profit(Qi) -   Qi
Error here: s.t.
let pQbe  the
0
i
wholesale price,
• Note it is separable (separate decision each Q)
Profit = 0.24*p
• Exactly the same thinking!
Risk = 0.08*p
• Last
P = (0.24p item: + 0.08p)
– )/(0.24p
= 0.75 - /(.32p)
– Profit: Profit*Probability Demand exceeds Q
– Risk: Loss * Probability Demand falls below Q
– 
• Set P = (Profit – )/(Profit + Risk)
= 0.75 –/(Profit + Risk)
20
20
 Solving for Qi
• Last item:
– Profit: Profit*Probability Demand exceeds Q
– Risk:Risk * Probability Demand falls below Q
– Also pay for each item Error: This was omitted. It is
• Balance the two sides: not needed later when we
calculate cost as, for
Profit*(1-P) –  example,
= Risk*P 53.4%*Wholesale
price, because it factors out
Profit –  = (Profit + Risk)*P
of everything.
• So P = (Profit – )/(Profit + Risk)
• In our case Profit = 24%, Risk = 8% so
P = .75 – /(.32*Wholesale Price)
How does the order quantity Q change with ?
21
21
 Q as a function of 

1400

1200

1000 Doh!
As we demand a higher return, we can accept
800

Q less and less risk that the item won’t sell. So,
600
We make less and less.
400

200

0
-3 2 7 12 17 22 27

 22
22
 Let’s Try It
Wholesale
Style Mean Std Dev RecommendedPrice
Order Quantity Order Quantity at Return 
Gail 1,017 388 1,278 $ 110.00 749 1778.1474%
Isis 1,042 646 1,478 $ 99.00 471
Entice 1,358 496 1,693 $ 80.00 568
Assault 2,525 680 2,984 $ 90.00 1767
Teri 1,100 762 1,614 $ 123.00 697
Electra 2,150 807 2,695 $ 173.00 2005
Stephanie
Seduced
1,113
4,017
1048
1113
1,819 $ 133.00
4,767 $ 73.00
Min Order 658
0
Anita
Daphne
3,296
2,383
2094
1394
4,708 $ 93.00
3,323 $ 148.00
Quantities! 1148
1938
26,359 10,000

Adding the Wholesale price brings

returns in line with expectations: if
we can make $26.40 = 24% of
$110 on a $1 investment, that’s a
2640% return 23
23
And Minimum Order Quantities
Maximize  Expected Profit(Qi) -  Qi
M*zi  Qi  600*zi (M is a “big” number)
zi binary (do we order this or not)

If zi =1 we
If zi =0 we
order at
order 0
least 600
24
24
 Solving for Q’s
Li() = Maximize Expected Profit(Qi) - Qi
s.t. M*zi  Qi  600*zi
zi binary
Two answers to consider:
zi = 0 then Li() = 0
zi = 1 then Qi is easy to calculate
It is just the larger of 600 and the Q that gives P = (profit -
)/(profit + risk) (call it Q*)
Which is larger Expected Profit(Q*) – Q* or 0?
Find the largest for which this is positive. For
greater than this, Q is 0.
25
25
 Solving for Q’s
Li() = Maximize Expected Profit(Qi) - Qi
s.t. M*zi  Qi  600*zi
zi binary
Let’s first look at the problem with z i = 1
Li() = Maximize Expected Profit(Qi) - Qi
s.t. Qi  600
How does Qi change with ?

26
26
 Adding a Lower Bound
1400
1200

1000
800

Q 600
400

200
0
0 5 10 15 20 25


27
27
 Objective Function
• How does Objective Function change
with ?
Li() = Maximize Expected Profit(Qi) – Qi
We know Expected Profit(Qi) is concave
$30,000

As  increases,
$25,000
When Q hits its
lower bound, it
Q decreases
$20,000 remains there.
After that Li()
and so does the
$15,000

decreases linearly
Expected Profit
$10,000

$5,000
28
$0 28
 The Relationships
$250
Expected Profit

$200 Capital Charge

Capital Charge = L(lambda)
$150 Expected Profit

$100 Q reaches
$50
minimum

$0 Past here, Q = 0
0 0.05 0.1 0.15 0.2 0.25
-$50

 29
29
 Solving for zi
Li() = Maximize Expected Profit(Qi) - Qi
s.t. M*zi  Qi  600*zi
zi binary
If zi is 0, the objective is 0
If zi is 1, the objective is
Expected Profit(Qi) - Qi
So, if Expected Profit(Qi) – Qi > 0, zi is 1
Once Q reaches its lower bound, Li() decreases,
when it reaches 0, zi changes to 0 and remains 0
30
30
 Error: That resolves
Answers the question of why we
got a higher return in
China with no cost

Recomm
Hong Kong differences!
ended Min Max
Order Wholesale Order Order Lambda Limit Lambda
Style Mean Std Dev Quantity Price Lagrange Order Quantity  Quantity Quantity Order? at 1200 limit at 6
Gail 1,017 388 1,278 $ 110.00 717 1864.10% 600 1,278 1 1869% 247
Isis 1,042 646 1,478 $ 99.00 600 600 1,478 1 1505% 195
Entice 1,358 496 1,693 $ 80.00 600 600 1,693 1 1647% 186
Assault 2,525 680 2,984 $ 90.00 1664 600 2,984 1 2160% 216
Teri 1,100 762 1,614 $ 123.00 648 600 1,614 1 1866% 235
Electra 2,150 807 2,695 $ 173.00 1973 600 2,695 1 3937% 408

In
Stephanie 1,113 1048 1,819 $ 133.00 600 600 1,819 1 1824% 224
Seduced 4,017 1113 4,767 $ 73.00 600 600 4,767 1 1752% 263
Anita 3,296 2094 4,708 $ 93.00 873 600 4,708 1 1928% 200
Daphne 2,383 1394 3,323 $ 148.00
26,359
1870
10,145
China?
600 3,323 1 3044% 322

Recomm
ended
China Min Max
Order Wholesale Order Order Lambda Limit Lambda
Style Mean Std Dev Quantity Price Lagrange Order Quantity  Quantity Quantity Order? at 1200 limit at 600
Gail 1,017 388 1,278 $ 110.00 1200 1824.04% 1200 1,278 1 1869% 2478%
Isis 1,042 646 1,478 $ 99.00 0 0 - 0 1505% 1952%
Entice 1,358 496 1,693 $ 80.00 0 0 - 0 1647% 1864%
Assault 2,525 680 2,984 $ 90.00 1714 1200 2,984 1 2160% 2160%
Teri 1,100 762 1,614 $ 123.00 1200 1200 1,614 1 1866% 2350%
Electra 2,150 807 2,695 $ 173.00 1988 1200 2,695 1 3937% 4083%
Stephanie 1,113 1048 1,819 $ 133.00 1200 1200 1,819 1 1824% 2247%
Seduced 4,017 1113 4,767 $ 73.00 0 0 - 0 1752% 1752%
Anita 3,296 2094 4,708 $ 93.00 1200 1200 4,708 1
31
1928% 2003%
Daphne 2,383 1394 3,323 $ 148.00 1902 1200 3,323 1 3044% 31
3225%
26,359 10,404
 First Order Objective:
With Prices
• It makes sense that the desired rate of
return on capital at risk, should get very
high, e.g., 1240%, before we would drop a
product completely. The $1 investment per
unit we used is ridiculously low. For
Seduced, that $1 promises 24%*$73 =
$17.52 in profit (if it sells). That would be
a 1752% return!
• Let’s use more realistic cost information.
32
32
 First Order Objective:
With Prices
• Maximize  = Expected Profit
 ciQi
• Can we achieve return ?
• L() = Max Expected Profit - ciQi > 0?
• What goes into ci ?
• Consider Rococo example
• Cost is $60.08 on Wholesale Price of $112.50 or
53.4% of Wholesale Price. For simplicity, let’s
assume ci = 53.4% of Wholesale Price for
everything from HK and 46.15% from PRC33
33
 Return on Capital
If everything isHong Kong Recomm
ended Min Max

made in one place,

Order Wholesale Order Order Lambda Limit Lambda
Style Mean Std Dev Quantity Price Lagrange Order Quantity  Quantity Quantity Order? at 1200 limit at 600
Gail 1,017 388 1,278 $ 110.00 608 36.19% 600 1,278 1 31.8% 42.2%
Isis 1,042 646 1,478 $ 99.00 600 600 1,478 1 28.5% 36.9%

where would you

Entice 1,358 496 1,693 $ 80.00 836 600 1,693 1 38.5% 43.6%
Assault 2,525 680 2,984 $ 90.00 1808 600 2,984 1 44.9% 44.9%
Teri 1,100 762 1,614 $ 123.00 0 0 - 0 28.4% 35.8%
Electra 2,150 807 2,695 $ 173.00 1299 600 2,695 1 42.6% 44.2%
Stephanie 1,113 1048 1,819 $ 133.00 0 0 - 0 25.7% 31.6%

Anita
make it?
Seduced

Daphne
4,017
3,296
2,383
1113
2094
1394
4,767 $ 73.00
4,708 $ 93.00
3,323 $ 148.00
26,359
2844
1090
915
10,000
600
600
600
4,767
4,708
3,323
1
1
1
44.9%
38.8%
38.5%
44.9%
40.3%
40.8%

China Recomm
ended Min Max
Order Wholesale Order Order Lambda Limit Lambda
Style Mean Std Dev Quantity Price Lagrange Order Quantity  Quantity Quantity Order? at 1200 limit at 600
Gail 1,017 388 1,278 $ 110.00 0 39.87% 0 - 0 36.8% 48.8%
Isis 1,042 646 1,478 $ 99.00 0 0 - 0 32.9% 42.7%
Entice 1,358 496 1,693 $ 80.00 1200 1200 1,693 1 44.6% 50.5%
Assault 2,525 680 2,984 $ 90.00 1889 1200 2,984 1 52.0% 52.0%
Teri 1,100 762 1,614 $ 123.00 0 0 - 0 32.9% 41.4%
Electra 2,150 807 2,695 $ 173.00 1395 1200 2,695 1 49.3% 51.1%
Stephanie 1,113 1048 1,819 $ 133.00 0 0 - 0 29.7% 36.6%
Seduced 4,017 1113 4,767 $ 73.00 2976 1200 4,767 1 52.0% 52.0%
Anita 3,296 2094 4,708 $ 93.00 1339 1200 4,708 1 34
44.9% 46.7%
Daphne 2,383 1394 3,323 $ 148.00 1200 1200 3,323 1 44.6% 34
47.2%
26,359 10,000
 Gail
$25,000 Make it in Hong Kong
$20,000 China China
Expected
Profit
$15,000
Make it in
above $10,000
Hong Kong
Target $5,000
Rate of
$0
Return 0% 10% 20% 30% 40% 50%
-$5,000
Stop
-$10,000
Making It.
Target Rate of Return
35
35
 What Conclusions?
• There is a point beyond which the smaller
minimum quantities in Hong Kong yield a higher
return even though the unit cost is higher. This is
because we don’t have to pay for larger quantities
required in China and those extra units are less
likely to sell.
• Calculate the “return of indifference” (when there
is one) style by style.
• Only produce in Hong Kong beyond this limit.

36
36
 That little
Where to Make What?
cleverness
Recommended Wholesale
was worth 2%
Order
Quantity
Using
Min
Order
Max
Order
Style Mean Std Dev Order Quantity Price Lambda  Quantity Quantity Order Lambda Limit
Gail 1,017 388 1,278 $ 110.00 0 42.19% 0 - 0 26.9%
Isis 1,042 646 1,478 $ 99.00 0 0 - 0 27.1%
Entice 1,358 496 1,693 $ 80.00 1200 1200 1,693 1 44.6%
Assault 2,525 680 2,984 $ 90.00 1794 1200 2,984 1 52.0%
Teri 1,100 762 1,614 $ 123.00 0 0 - 0 28.8%
Electra 2,150 807 2,695 $ 173.00 1283 1200 2,695 1 49.3%
Stephanie 1,113 1048 1,819 $ 133.00 0 0 - 0 27.1%
Seduced 4,017 1113 4,767 $ 73.00 2822 1200 4,767 1 52.0%
Anita 3,296 2094 4,708 $ 93.00 1200 1200 4,708 1 44.9%
Daphne 2,383 1394 3,323 $ 148.00 1200 1200 3,323 1 44.6%
Same Styles Made in Hong Kong
Gail 1,017 388 1,278 $ 110.00 600 600 1,278 1 42.2%
Isis 1,042 646 1,478 $ 99.00 0 0 - 0 36.9%
Entice 1,358 496 1,693 $ 80.00 0 0 - 0 43.6%
Assault 2,525 680 2,984 $ 90.00 0 0 - 0 44.9%
Teri
Electra
Stephanie
1,100
2,150
1,113
762
807
1048
1,614
2,695
1,819
$
$
$
123.00
173.00
133.00
0
0
0
Not a big deal. Make
0
0
0
-
-
-
0
0
0
35.8%
44.2%
31.6%
Seduced
Anita
Daphne
4,017
3,296
2,383
1113
2094
1394
4,767
4,708
3,323
$
$
$
73.00
93.00
148.00
0
0
0
0
0
0
Gail in HK at
-
-
-
0
0
0
44.9%
40.3%
40.8%
10,099
minimum
37
37
 What Else?
• Kai’s point about making an amount now
that leaves less than the minimum order
quantity for later
• Secondary measure of risk, e.g., the
variance or std deviation in Profit.

38
38