Specialty Toys: Case Study

Ngo Thanh Ha
Khuong Thi Thuy Tien
Tran Bich Phuong
Dang Khanh Linh
Dam Thi Tuyet
National Economics University
IS310 - Quantitative Analysis

Specialty Toys: Case Study

Executive Summary
Specialty Toys, Inc. is a manufacturer of new and innovative childrens toys which includes
the Weather Teddy. The Weather Teddy has a built-in barometer that provides one of five
standard responses about the weather when a child presses the teddy bears hand. The
company recently reached out to our team to prepare a managerial report addressing, but not
limited to, the following issues: normal probability distribution in relation to demand
approximation, the probability of stock-outs for certain quantities and the projected profits
associated with certain order quantities. The purpose of this managerial report is to address
the concerns of the management team at Specialty Toys, Inc. and also to provide a
recommended order quantity for the Weather Teddy, the probability of stock-outs related to
specific order quantities, and the potential profits associated with certain order quantities.

Specialty Toys: Case Study

Specialty Toys Business Cycle

The company sells a variety of toys throughout the year. However, Specialty Toys plans to
release the Weather Teddy in October, before the holiday season is officially underway.
Management has determined that this is the best time to release a holiday gift because many
families have already begun shopping for holiday gifts at this time. In order to have the
Weather Teddy on the shelf by October, the company must place a one-time order with its
manufacturer in either June or July. Due to the large gap between when orders are placed and
actual products are produced, the most important question the company faces is determining
the correct number of units to purchase in order to meet customer demand. The company
must balance this desire to meet customer demand with the potential loses that could result
from having excess inventory left over from the holiday season that must be sold at a reduced
cost.
There is considerable disagreement between the management team over what the correct
order quantity should be. Estimates have ranged from 15,000 to 28,000. This variation clearly
shows a large degree of disagreement amongst the management team over how successful
they believe the Weather Teddy will be. Through our discussions with management, we have
learned that each Weather Teddy will be sold for $24. Each toy will cost $16 for the company
to manufacture and sell. Therefore, the net profit for each Weather Teddy sold is $8.
However, any unsold Weather Teddys after the holiday season will be sold for a reduced
price of $5. Based on this discounted price, Specialty Toys will end up losing $11 on every
toy left over from the holiday season. In addition, Specialtys senior sales forecaster predicted
an expected demand of 20,000 units with a .90 probability that demand would be between
10,000 and 30,000 units. We used these management estimates to perform our analysis and
probability calculations.

Specialty Toys: Case Study

Normal Probability Distribution

This managerial report is based on the Senior Sales Forecasters prediction that expected
demand for the Weather Teddy will be 20,000 units and that there is a 90% probability that
unit demand will be between 10,000 and 30,000 units.
Below is a distribution graph showing the details of the forecasters prediction. The mean of
the distribution is the expected 20,000 units and the standard deviation is 6079 units. Z
scores for the 90% probability that units sold will be between 10,000 and 30,000 units are 1.645 and +1.645, respectively.

At x = 30,000,

= 1.645

Normal distribution 20,000

Normal distribution

P(lower)

P(upper)

,9500

,0500

mean

std.dev

1,645

30.000

20.000

6.079

Specialty Toys: Case Study

Likelihood of Stock-Outs for Specific Order Quantities

As noted in the Specialty Toys Business Model section, the company must balance the
additional profits associated with each toy sold ($8) against the losses that will be incurred for
any toys leftover after the holiday season ($11). Below, we provide the probability that
Specialty Toys will run out of the Weather Teddy based on estimated quantities provided to
us by management.
@ 15,000

P(stockout) = 0.7939
Analysis: There is an approximately 79.39% chance that Specialty Toys will run out of the
Weather Teddy if the company orders 15,000 units.
@ 18,000

P(stockout) = 0.6293
Analysis: There is an approximately 62.93% chance that Specialty Toys will run out of the
Weather Teddy if the company orders 18,000 units.
@ 24,000

P(stockout) = 0.2546

Specialty Toys: Case Study

Analysis: There is an approximately 25.46% chance that Specialty Toys will run out of the
Weather Teddy if the company orders 24,000 units.
@ 28,000

P(stockout) = 0.0934
Analysis: There is an approximately 9.34% chance that Specialty Toys will run out of the
Weather Teddy if the company orders 28,000 units.

Specialty Toys: Case Study

Profit Potential
We looked at the profitability associated with three different quantities: 10,000, 20,000 and
30,000.
Order Quantity: 15,000

Unit
Sales
10,000
20,000
30,000

Total
Cost
240,000
240,000
240,000

Sales
at $24
at $5
240,000
360,000
360,000

25,000
0
0

Profit
25,000
120,000
120,000

Order Quantity: 18,000

Unit
Sales
10,000
20,000
30,000

Total
Cost
288,000
288,000
288,000

Sales
at $24
at $5
240,000
432,000
432,000

40,000
0
0

Profit
-8,000
144,000
144,000

Order Quantity: 24,000

Unit
Sales
10,000
20,000
30,000

Total
Cost
384,000
384,000
384,000

Sales
at $24
at $5
240,000
480,000
576,000

70,000
20,000
0

Profit
-74,000
116,000
192,000

Order Quantity: 28,000

Unit
Sales

Total
Cost

Sales
at $24
at $5

Profit

Specialty Toys: Case Study

10,000
20,000
30,000

448,000
448,000
448,000

240,000
480,000
672,000

90,000
40,000
0

-118,000
72,000
224,000

Since net profit is fixed, the company will earn more money for each unit that is sold.
However, using net profit to determine the optimal order quantity is misleading since it gives
no consideration to lost sales due to insufficient inventory or losses related to excess
inventory sold for a reduced price.

Specialty Toys: Case Study

Accounting and Economic Profit Potential

One of Specialtys managers felt the profit potential was so great that the order quantity
should have a 70% chance of meeting demand and only a 30% chance of any stock-outs.
What quantity should be ordered under this policy, and what is the projected profit under the
three sales scenarios?
In order to calculate the quantity needed to ensure a 70% chance of meeting demand, we first
determined the Z score associated with a 70% probability. Using Microsoft Excel, we
calculated the Z score to be approximately .5244, rounding to four decimals. We can now
calculate the quantity associated with a 70% probability by inputting in our known values to
the following formula:
P (X < K) = 0.7
P (Z < (K 20,000) / 6079) = 0.7
(K 20,000) / 6079 = 0.5244
K = 20000 + 6079 * 0.5244 = 20000 + 2675 = 23,188 units to be ordered
In order to assure a 70% chance of meeting customer demand, we recommend that Specialty
Toys place a one-time order for 23,188 toys. The projected profits under the 3 scenarios are
computed below.
Order Quantity: 23,188

Unit Sales
10,000
20,000
30,000

Total
Cost
371,008
371,008
371,008

Sales
at $24
at $5
240,000
480,000
556,512

65,940
15,940
0

Profit
-65,068
124,932
185,504

Specialty Toys: Case Study

Recommendations
There were several different factors that we took into account when making our
recommendation and deciding on a suitable order quantity. Factors to consider included the
probability of a stock out, potential profits from several different possible quantities
demanded, loss of profits in the event a stock out does take place, and finally added revenues
associated with the discount sale of excess goods on hand.
After analyzing the results of our calculations based on managements expectations, we find
the probability of demand being greater than or equal to 15,000 or 18,000 units is too large
for these quantities to be sufficient. Ordering a quantity of goods at far below level s of
expected demand create a high probability (80% and 63%) that Specialty Toys will sell out of
Weather Teddy stock and lose sales revenue. The probability of stock outages occurring
drastically decrease to 25 % and 9% in forecasts of higher quantities demanded of 24,000 and
28,000 units, respectively.
In addition, a single-period inventory model recommends an order quantity that maximizes
expected profit based on the following formula:

P(Demand Q* )

cu
cu co

where P(Demand Q* ) is the probability that demand is less than or equal to the recommended
order quantity, Q * . cu is the cost of underestimating demand (having lost sales because of a
stockout) and co is the cost per unit of overestimating demand (having unsold inventory).
Specialty will sell Weather Teddy for $24 per unit. The cost is $16 per unit. So, cu = $24 - $16
= $8. If inventory remains after the holiday season, Specialty will sell all surplus inventory
for $5 a unit. So, co = $16 - $5 = $11.

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Specialty Toys: Case Study

P(Demand Q* )

8
0.4211
8 11

0.4211

0.5789
Q*
z = -0.20

The profit projections for this order quantity are computed below:
Order Quantity: 18,784

Scenario

1
2
3
4
Breakevent

Quantity
Order

10000
20000
30000
18784
9392

Gross
Profit

240000
480000
720000
450816
225408

Cost of
Good
Sold
160000
320000
480000
300544
150272

Net Profit

80000
160000
240000
150272
75136

Foregone
Sales due to
Inadequate
Inventory
-70272
N/A
N/A
N/A
-75136

Losses Due Economic

to Excess
Profit
Inventory
N/A
13376
123376
N/A
N/A

9728
146624
116624
150272
0

The data in table above captures both the forgone profits and losses due to quantities
demanded differing from our recommended quantity ordered. We also realize the high
economic profit of the scenario where quantities demanded would actually equal our
recommended order quantity, $150,272. Lastly, we calculated the breakeven point in which

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Specialty Toys: Case Study

an actual demanded quantity of 9,392 would cause net profit to equal forgone sales due to
inadequate inventories.
Based on the information in the case, we recommend a quantity with a large probability of
meeting customer demand. In order to have a better understanding of the specific quantity of
units needed, more information is necessary including industry sales trends of recent products
and sales history of similar products. Given the risks associated with over purchasing,
Specialty Toys management would also need to provide the interval of probability in which
they expect to meet consumer demand.
Other options that we alternatively recommend would be to negotiate higher rates with
contract manufacturers to produce additional rush orders in October if demand is high when
the toys are released. Additionally, Specialty Toys could sign contracts with discount retailers
prior to October specifying a fixed unit price (above the reduced price the toys would be sold
at) for all excess toys to avoid excess loss.

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