The New Science of Retailing by Marshall Fisher Ananth Raman

Author:Marshall Fisher,Ananth Raman
Language: eng
Format: epub
Publisher: Harvard Business Press
Published: 2011-07-06T04:00:00+00:00

How Misaligned Incentives Affect Inventory Levels, Fill Rates, Sales, and Profit in a Supply Chain

To understand how misaligned incentives can affect inventory levels, fill rates, sales, and profit in a supply chain, consider the following fictional example.

A recent college graduate, Anna Sheen, has returned to her hometown of Hamptonshire to start a newspaper called the Hamptonshire Express2. She publishes and sells it on her own. The marginal cost of printing a copy of the Express is 20¢, while each one sells for $1. Anna throws out unsold copies; day-old news, as the saying goes, isn’t worth the paper that it’s printed on. Daily demand follows the normal distribution, with a mean of 500 papers and a standard deviation of 100. How many newspapers should Anna stock each day?

Table 5-1 shows the optimal stocking values and the resulting fill rates, sales, and profits.3 Notice that the stocking quantity exceeds the mean daily demand. Anna’s gains from selling a newspaper (80¢ per copy) far exceed the cost of overstocking a newspaper (20¢). Hence, she errs on the side of overstocking and obtains high fill rates.

After several years of doing all the work herself, Anna decides to start selling her papers through an agent, Ralph. Their agreement requires Anna to transfer papers to Ralph at 80¢ each. Ralph then sells them for $1 each and handles any unsold newspapers. Demand doesn’t change.

Ralph’s optimal stocking quantity, as shown in table 5-1, is less than 500 because Ralph’s gains from selling an additional copy of a newspaper (20¢) are less than the cost he incurs from having an unsold one (80¢). Consequently, Ralph stocks less than 500 units, resulting in lower fill rates, sales, and profits for the supply chain as a whole.

Notice what hasn’t changed between the two scenarios: printing costs, retail demand, and retail price. The lower fill rates, sales, and profits result from the fact that Anna is selling through Ralph. You can trace the loss, in other words, to Ralph’s incentives’ differing from Anna’s.

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