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Inventory Management For Quantity Discount & Trade Promotion

1) The document discusses inventory management strategies for quantity discounts and trade promotions. It covers topics like how quantity discounts can improve supply chain coordination and profits. 2) An example is provided to illustrate how to design a quantity discount that incentivizes ordering the optimal lot size. The impact of trade promotions on lot sizes and forward buying is also examined. 3) The case study of KAR Foods looks at how the company worked to reduce inventory levels by lowering order fulfillment costs. This allowed them to reconsider their discounting strategy to further optimize supply chain performance.

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97 views25 pages

Inventory Management For Quantity Discount & Trade Promotion

1) The document discusses inventory management strategies for quantity discounts and trade promotions. It covers topics like how quantity discounts can improve supply chain coordination and profits. 2) An example is provided to illustrate how to design a quantity discount that incentivizes ordering the optimal lot size. The impact of trade promotions on lot sizes and forward buying is also examined. 3) The case study of KAR Foods looks at how the company worked to reduce inventory levels by lowering order fulfillment costs. This allowed them to reconsider their discounting strategy to further optimize supply chain performance.

Uploaded by

durga
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Inventory Management for


Quantity Discount & Trade Promotion

Peeyush Pandey
Assistant Professor
IIM Rohtak

.
Learning Objectives

1. Understand the impact of quantity discounts on lot size and cycle inventory.

2. Devise appropriate discounting schemes for a supply chain.

3. Understand the impact of trade promotions on lot size and cycle inventory.

4. Application of discounting scheme in real life problem: KAR Foods


Why Quantity Discounts?

• Quantity discounts can increase the supply chain surplus for the following
two main reasons

1. Improved coordination to increase total supply chain profits

2. Extraction of surplus through price discrimination


Quantity Discounts for Commodity Products
Example:
D = 120,000 bottles/year,

Manufacturer’s order cost SM = $250,

Manufacturer’s holding cost hM = 0.2,

Manufacturing cost of product CM = $2

Retailer’s order cost SR = $100,

Retailer’s holding cost hR = 0.2,

Cost of product for retailer CR = $3,


Quantity Discounts for Commodity Products

Annual supply chain cost = $6,008 + $3,795 = $9,803


Locally Optimal Lot Sizes

Annual cost for DO and


manufacturer

Annual supply chain cost= $5,106 + $4,059 = $9,165


Designing a Suitable Lot Size-Based Quantity Discount

• Design a suitable quantity discount that gets DO to order in lots of 9,165


units when its aims to minimize only its own total costs
• Manufacturer needs to offer an incentive of at least $264 per year to DO in
terms of decreased material cost if DO orders in lots of 9,165 units
• Appropriate quantity discount is $3 if DO orders in lots smaller than 9,165
units and $2.9978 for orders of 9,165 or more
Quantity Discounts When Firm Has Market Power

Demand curve = 360,000 – 60,000p


Production cost = CM = $2 per bottle

p to maximize ProfR
Quantity Discounts When Firm Has Market Power

CR = $4 per bottle, p = $5 per bottle

Total market demand = 360,000 – 60,000p = 60,000

ProfR = (5 – 4)(360,000 – 60,000 × 5) = $60,000

ProfM = (4 – 2)(360,000 – 60,000 × 5) = $120,000

Coordination

ProfSC = (p – CM)(360,000 – 60,000p)

Coordinated retail price

ProfSC = ($4 – $2) x 120,000 = $240,000


Two-Part Tariff

• Manufacturer charges its entire profit as an up-front franchise fee ff


• Sells to the retailer at cost CM
• Retail pricing decision is based on maximizing its profits
• Effectively maximizes the coordinated supply chain profit
Trade Promotions

• Trade promotions are price discounts for a limited period of time


• Key goals

1. Induce retailers to use price discounts, displays, or advertising to spur


sales

2. Shift inventory from the manufacturer to the retailer and the customer

3. Defend a brand against competition


Forward Buying Inventory Profile
Forward Buy

• Optimal order quantity

• Retailers are often aware of the timing of the next promotion


Impact of Trade Promotions on Lot Sizes

Q* = 6,325 bottles, C = $3 per bottle


d = $0.15, D = 120,000, h = 0.2, SR = $100

Cycle inventory at DO= Q*/2 = 6,324/2 = 3,162.50 bottles

Average flow time = Q*/2D = 6,324/(2D) = 0.3162 months

d dD CQ *
Q  
(C – d )h C – d
Impact of Trade Promotions on Lot Sizes
• With trade promotions

Cycle inventory at DO= Qd/2 = 38,236/2 = 19,118 bottles

Average flow time = Qd/2D = 38,236/(20,000)

= 1.9118 months

Forward buy = Qd – Q*
= 38,236 – 6,325
= 31,911 bottles
Case Study: Pricing and Delivery at KAR Foods

• KAR- Large Brazilian food processing company headquartered in Sao Paulo.


• The Company had become a major global player after several acquisitions
across the world.
• The company sold its product to large supermarket chains in Brazil.
• Carlos Ramos, Head of Supply chain at KAR was concerned about the
inventory level.
Supermarket Chains

• A supermarket chain purchased 10000 kg of product at price 4 Real/Kg


• KAR incurred a cost of 2.50 Real/Kg
• KAR offered quantity discount of 2% if customers ordered lots of 27500 kg or
more.
• Fixed order processing cost of KAR was 4000 Real.
• Fixed ordering cost of supermarket was 100 Real.
• Holding cost for both was 20% of product cost.
Supply Chain Improvement at KAR

• A quick review of status quo by Carlos Ramos identified several opportunities for
improvements.
• He decided to focus on large amount of inventory
• He thought that reduction in inventory will:
– Would free up the space

– Would free up the blocked capital

– Streamline the process

• Carlos changed the processes and invested in the technologies to reduce the cost of order
fulfillment.
• Order placement cost reduced to 400 Real from 4000 Real.
Result

• There was very little decrease in order size.


• Enforced KAR to store large inventory
• He was concerned about the inventory
Questions

1. What do you think of discounting scheme that KAR has used historically?
Do you think it was justified given the circumstances?

2. Once KAR has reduced its cost per order to 400 Real, what are the
downsides of leaving the discounting schemes unchanged?

3. What should Carlos suggest to Vanessa at the upcoming meeting? What are
the potential gains for KAR from this suggestion?
Solution

• For Customer (Supermarket chain)


Demand D = 10,000 / month = 120,000 / year
Unit cost C = 4
Holding cost H = 4*0.2 = 0.8
Fixed cost / order S = 100
• For KAR
Demand D = 10,000 / month = 120,000 / year
Unit cost C = 2.50
Holding cost H = 2.5*0.2 = 0.5
Fixed cost / order S = 4,000
• The optimal order size for a supermarket chain is thus given by (based
on its fixed cost / order)

2 DS 2 120, 000 100


Q   5, 477
H 0.8

Order + holding cost (supermarket chain)

= (5,477/2)*0.8 + (120,000/5,477)*100 = 4,382

Order + holding cost per year for KAR

= (5,477/2)*0.5 + (120,000/5,477)*4,000 = 89,005 Real


• Order size of 27,51 would minimize the total supply chain (supermarket chain +
KAR) order + holding cost.
• Shifting to the optimal order size of 27,512:
– lowers the annual cost for KAR by 64,680 Real

– Raise the cost for the supermarket chain by 7,059 Real/year.

• KAR must compensate the chain at least 7,059 / 120,000 = 0.0588 Real per unit
• The maximum compensation that KAR can provide is 64,680 / 120,000 = 0.539
real / Unit.
• With reduced fixed order cost of 400 Real, the supermarket chains will still
order 27,500 units per lot.
• Annual order + holding cost (KAR) = 8,620 real
• With no quantity discount, supermarket chains would order lot sizes of 5,477
units per lot
• Annual order + holding cost (KAR) = 10,132 real
• Profit for KAR with large order = 1,512 Real.
• Loss for KAR because of discount = 0.02*10,000*4 = 9,600 Real.
Thank You

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