Research.(briefs)

In order to increase product sales in economic times that have been labeled as "bad to habitually worse" by Business Week, consumers must be given options. This month we highlight two articles that describe scheduling and logistics methods that create more purchasing power. The first article presents analysis showing that both the buyer and seller may benefit from engaging in a series of one-time purchase contracts rather than entering into a long-term contract. The second article develops a new methodology for simulatenously determining the location of a new warehouse and the systemwide schedule of deliveries required to move goods from, the factory to many customers. Both articles appear in the August issue of IIE Transactions (Volume 40, No. 8).

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Dynamic procurement saves money

Common wisdom suggests that long-term contracts or buying in bulk to take advantage of quantity discounts saves money. But by committing to buy large quantities up front, a buyer gives up his negotiating leverage and may ultimately pay more than if he had made periodic (dynamic) purchases under a series of simple wholesale price contracts. From analysis of data spanning several years, a consulting firm for a major manufacturer of finished goods saw strong indications that the manufacturer was able to influence its raw material costs by using dynamic procurement. The consulting firm observed that higher inventory levels often led to lower unit purchasing costs for the manufacturer.

In "Dynamic Procurement in a Capacitated Supply Chain Facing Uncertain Demand," professors Feryal Erhun of Stanford University, Pinar Keskinocak of Georgia Institute of Technology and Sridhar Tayur of Carnegie Mellon University analyze this phenomenon in a framework where the buyer faces uncertain demand and needs to decide how much to order in each period, while the supplier needs to decide her price in each period and possibly her capacity level. Both parties act in their own self-interest. The buyers "negotiating advantage" comes from her on-hand inventory: high levels allow her to back away from the table and thereby force the supplier to offer a lower price. The authors derive both parties' optimal decisions in this context and analyze how the timing of decisions and additional demand information affect the optimal decisions.

The authors show that the optimal pattern of prices may be increasing or decreasing as time passes, unlike in other situations where typically one of the two patterns prevails. When the supplier can choose his capacity as well as the prices for a wide range of cost and demand parameters, dynamic procurement is beneficial for both parties. Furthermore, contrary to common intuition, more capacity is not always better for the supplier, even when it comes for free, because tighter capacity often allows the supplier to charge higher prices.

The authors point out that, beyond the direct economic benefits, dynamic procurement offers other advantages: It reduces potential inventory risks for the buyer and capacity commitment risks for the supplier, and it allows the buyer to spread financial commitments over a period of time.

CONTACT: Feryal Erhun;

ferhun@stanford.edu; (650) 804-1630;

Department of Management Science and Engineering, Stanford University, Stanford, CA 94305-4026

Integrating location and inventory decisions

A manufacturer of snack foods had been shipping goods directly from its factory to the retailers that offer its products. With the cost of transportation rising due to increasing fuel prices, managers at the company were struggling with the decision of whether to build a finished goods warehouse to fulfill customer orders, and, if so, where. The warehouse would allow for high utilization of truck capacity between the factory and warehouse and could position inventory closer to the retailers, thereby reducing delivery costs.

This company came to professors Halit Uster and Sila Cetinkaya of Texas A&M University and Burcu Keskin of the University of Alabama for help. As a benchmar, the professors first needed to determine the best way to operate under the then-current distribution strategy, where the main trade-off was between the cost of transportation, which exhibits economies of scale, and the cost of holding inventory. They needed to develop an approach to find the best integrated location-inventory strategy to coordinate consolidated loads of shipments to a new-intermediate warehouse from the factory and direct shipments from the intermediate warehouse to the retailers. For this problem, systemwide transportation, ordering and inventory holding costs need to be considered simultaneously. The first problem with direct shipments was easy to solve, but the latter problem had not been solved before and required the development of a new method.

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In "Integrated Warehouse Location and Inventory Decisions in a Three-Tier Distribution System," the three professors develop mathematical proofs showing that optimal solutions have certain characteristics that enable them to eliminate the vast majority of alternatives from consideration and to develop efficient solution methods for the problem.

The paper demonstrates that integration of facility location and inventory decisions is essential for effective logistical coordination. Numerical results show that substantial cost savings--typically about 40 percent but often much more--can be realized by using a system with an intermediate warehouse where the location and shipment decisions are jointly optimized, rather than direct shipments between the factory and the retailers. Furthermore, the authors' methodology produces solutions that offer a 10 percent savings over those obtained from other sophisticated but less integrated approaches.

Contact: CONTACT: Halit U ster;

uster@tamu.edu; (979) 845-9473; Department of Industrial and Systems Engineering, Texas A&M University, College Station, TX 77843

Candace "Candi" Yano, is a professor at the University of California at Berkeley, where she holds a joint appointment in the department of industrial engineering and operations research and in the Haas School of Business. She is the editor-in-chief of IIE Transactions and has been a member of IIE since 1983.

ABOUT IIE TRANSACTIONS

IIE Transactions is IIE's flagship research journal and is published monthly. It aims to foster exchange among researchers and practitioners in the industrial engineering community by publishing papers that are grounded in science and mathematics and motivated by engineering applications.

To subscribe, call (800) 494-0460 or (770) 449-0460.

EXECUTIVE SUMMARIES: EDITED BY CANDACE YANO