1

1
Sport Obermeyer Case
John H. Vande Vate
Spring, 2006

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2
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


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3
Describe the Challenge
Long lead times:
Its November 92 and the company is starting
to make firm commitments for its 93 94
season.
Little or no feedback from market
First real signal at Vegas trade show in March
Inaccurate forecasts
Deep discounts
Lost sales





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4
Production Options
Hong Kong
More expensive
Smaller lot sizes
Faster
More flexible

Mainland (Guangdong, Lo Village)
Cheaper
Larger lot sizes
Slower
Less flexible



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5
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)


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6
The Product
Gender
Styles
Colors
Sizes
Total Number of SKUs: ~800

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7
Service
Deliver matching collections
simultaneously
Deliver early in the season

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8
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)
Retailers want full delivery prior to start of season
(early September 93)
Replenishment orders from Retailers

Quotas!

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9
Quotas
Force delivery earlier in the season
Last man loses.


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10
The Critical Path of the SC
Contract for Greige
Production Plans set
Dying and printing
YKK Zippers


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11
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?


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



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Sample Problem

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
Individual Forecasts

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14
Recall the Newsvendor
Ignoring all other constraints
recommended target stock out probability
is:
1-Profit/(Profit + Risk)
=8%/(24%+8%) = 25%


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Ignoring Constraints
Style Mean Std Dev Recommended Order Quantity
Gail 1,017 388 1,278
Isis 1,042 646 1,478
Entice 1,358 496 1,693
Assault 2,525 680 2,984
Teri 1,100 762 1,614
Electra 2,150 807 2,695
Stephanie 1,113 1048 1,819
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!
Everyone has a 25%
chance of stockout
Everyone orders
Mean + 0.6745s
P = .75 [from .24/(.24+.08)]
Probability of being less than
Mean + 0.6745s is 0.75

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Constraints
Make at least 10,000 units in initial phase
Minimum Order Quantities


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Objective for the first 10K
First Order criteria:
Return on Investment:

Second Order criteria:
Standard Deviation in Return

Worry about First Order first


Expected Profit
Invested Capital

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18
First Order Objective
Maximize t =

Can we exceed return t*?
Is
L(t*) = Max Expected Profit - t*Invested Capital > 0?
Expected Profit
Invested Capital

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First Order Objective
Initially Ignore the prices we pay
Treat every unit as though it costs Sport
Obermeyer $1
Maximize l =

Can we achieve return l?
L(l) = Max Expected Profit - lS Q
i
> 0?



Expected Profit
Number of Units Produced

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Solving for Q
i
For l fixed, how to solve
L(l) = Maximize S Expected Profit(Q
i
) - l S Q
i

s.t. Q
i
0
Note it is separable (separate decision each Q)
Exactly the same thinking!
Last item:
Profit: Profit*Probability Demand exceeds Q
Risk: Loss * Probability Demand falls below Q
l?
Set P = (Profit l)/(Profit + Risk)
= 0.75 l/(Profit + Risk)
Error here: let p be the
wholesale price,
Profit = 0.24*p
Risk = 0.08*p
P = (0.24p l)/(0.24p + 0.08p)
= 0.75 - l/(.32p)

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Solving for Q
i
Last item:
Profit: Profit*Probability Demand exceeds Q
Risk:Risk * Probability Demand falls below Q
Also pay l for each item
Balance the two sides:
Profit*(1-P) l = Risk*P
Profit l = (Profit + Risk)*P
So P = (Profit l)/(Profit + Risk)
In our case Profit = 24%, Risk = 8% so
P = .75 l/(.32*Wholesale Price)
How does the order quantity Q change with l?

Error: This was omitted. It is
not needed later when we
calculate cost as, for
example, 53.4%*Wholesale
price, because it factors out
of everything.

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0
200
400
600
800
1000
1200
1400
-3 2 7 12 17 22 27
Q as a function of l
l
Q
Doh!
As we demand a higher return, we can accept
less and less risk that the item wont sell. So,
We make less and less.

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Lets Try It
Style Mean Std Dev Recommended Order Quantity
Wholesale
Price
Order Quantity at Return l
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 1,113 1048 1,819 133.00 $ 658
Seduced 4,017 1113 4,767 73.00 $ 0
Anita 3,296 2094 4,708 93.00 $ 1148
Daphne 2,383 1394 3,323 148.00 $ 1938
26,359 10,000
Min Order
Quantities!
Adding the Wholesale price brings
returns in line with expectations: if
we can make $26.40 = 24% of
$110 on a $1 investment, thats a
2640% return

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And Minimum Order Quantities
Maximize S Expected Profit(Q
i
) - l SQ
i

M*z
i
Q
i
600*z
i
(M is a big number)

z
i
binary (do we order this or not)





If z
i
=1 we
order at
least 600
If z
i
=0 we
order 0

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Solving for Qs
L
i
(l) = Maximize Expected Profit(Q
i
) - lQ
i

s.t. M*z
i
Q
i
600*z
i

z
i
binary
Two answers to consider:
z
i
= 0 then L
i
(l) = 0
z
i
= 1 then Q
i
is easy to calculate
It is just the larger of 600 and the Q that gives P =
(profit - l)/(profit + risk) (call it Q*)
Which is larger Expected Profit(Q*) lQ* or 0?
Find the largest l for which this is positive. For
l greater than this, Q is 0.


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Solving for Qs
L
i
(l) = Maximize Expected Profit(Q
i
) - lQ
i

s.t. M*z
i
Q
i
600*z
i

z
i
binary
Lets first look at the problem with z
i
= 1
L
i
(l) = Maximize Expected Profit(Q
i
) - lQ
i

s.t. Q
i
600


How does Q
i
change with l?

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Adding a Lower Bound
l
Q
0
200
400
600
800
1000
1200
1400
0 5 10 15 20 25
0
200
400
600
800
1000
1200
1400
0 5 10 15 20 25

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Objective Function
How does Objective Function change
with l?
L
i
(l) = Maximize Expected Profit(Q
i
) lQ
i
We know Expected Profit(Q
i
) is concave
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
- 500 1,000 1,500 2,000 2,500 3,000 3,500
As l increases,
Q decreases
and so does the
Expected Profit
When Q hits its
lower bound, it
remains there.
After that L
i
(l)
decreases linearly

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The Relationships
-$50
$0
$50
$100
$150
$200
$250
0 0.05 0.1 0.15 0.2 0.25
Expected Profit
Capital Charge
L(lambda)
l/110
Q reaches
minimum
Capital Charge =
Expected Profit
Past here, Q = 0

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Solving for z
i
L
i
(l) = Maximize Expected Profit(Q
i
) - lQ
i

s.t. M*z
i
Q
i
600*z
i

z
i
binary
If z
i
is 0, the objective is 0
If z
i
is 1, the objective is
Expected Profit(Q
i
) - lQ
i

So, if Expected Profit(Q
i
) lQ
i
> 0, z
i
is 1
Once Q reaches its lower bound, L
i
(l) decreases,
when it reaches 0, z
i
changes to 0 and remains 0


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Style Mean Std Dev
Recomm
ended
Order
Quantity
Wholesale
Price Lagrange Order Quantity l
Min
Order
Quantity
Max
Order
Quantity Order?
Lambda Limit
at 1200
Lambda
limit at 600
Gail 1,017 388 1,278 110.00 $ 717 1864.10% 600 1,278 1 1869% 2478%
Isis 1,042 646 1,478 99.00 $ 600 600 1,478 1 1505% 1952%
Entice 1,358 496 1,693 80.00 $ 600 600 1,693 1 1647% 1864%
Assault 2,525 680 2,984 90.00 $ 1664 600 2,984 1 2160% 2160%
Teri 1,100 762 1,614 123.00 $ 648 600 1,614 1 1866% 2350%
Electra 2,150 807 2,695 173.00 $ 1973 600 2,695 1 3937% 4083%
Stephanie 1,113 1048 1,819 133.00 $ 600 600 1,819 1 1824% 2247%
Seduced 4,017 1113 4,767 73.00 $ 600 600 4,767 1 1752% 2634%
Anita 3,296 2094 4,708 93.00 $ 873 600 4,708 1 1928% 2003%
Daphne 2,383 1394 3,323 148.00 $ 1870 600 3,323 1 3044% 3225%
26,359 10,145
Answers
China
Hong Kong
In
China?
Style Mean Std Dev
Recomm
ended
Order
Quantity
Wholesale
Price Lagrange Order Quantity l
Min
Order
Quantity
Max
Order
Quantity Order?
Lambda Limit
at 1200
Lambda
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 1928% 2003%
Daphne 2,383 1394 3,323 148.00 $ 1902 1200 3,323 1 3044% 3225%
26,359 10,404
Error: That resolves
the question of why we
got a higher return in
China with no cost
differences!

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First Order Objective:
With Prices
It makes sense that l, 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!
Lets use more realistic cost information.




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First Order Objective:
With Prices
Maximize l =

Can we achieve return l?
L(l) = Max Expected Profit - lSc
i
Q
i
> 0?
What goes into c
i
?
Consider Rococo example
Cost is $60.08 on Wholesale Price of $112.50 or
53.4% of Wholesale Price. For simplicity, lets
assume c
i
= 53.4% of Wholesale Price for
everything from HK and 46.15% from PRC



Expected Profit
S c
i
Q
i

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Return on Capital
Hong Kong
Style Mean Std Dev
Recomm
ended
Order
Quantity
Wholesale
Price Lagrange Order Quantity l
Min
Order
Quantity
Max
Order
Quantity Order?
Lambda Limit
at 1200
Lambda
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%
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%
Seduced 4,017 1113 4,767 73.00 $ 2844 600 4,767 1 44.9% 44.9%
Anita 3,296 2094 4,708 93.00 $ 1090 600 4,708 1 38.8% 40.3%
Daphne 2,383 1394 3,323 148.00 $ 915 600 3,323 1 38.5% 40.8%
26,359 10,000
Style Mean Std Dev
Recomm
ended
Order
Quantity
Wholesale
Price Lagrange Order Quantity l
Min
Order
Quantity
Max
Order
Quantity Order?
Lambda Limit
at 1200
Lambda
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 44.9% 46.7%
Daphne 2,383 1394 3,323 148.00 $ 1200 1200 3,323 1 44.6% 47.2%
26,359 10,000
China
If everything is
made in one place,
where would you
make it?

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Gail
-$10,000
-$5,000
$0
$5,000
$10,000
$15,000
$20,000
$25,000
0% 10% 20% 30% 40% 50%
Hong Kong
China
Expected
Profit
above
Target
Rate of
Return
Target Rate of Return
Make it in
China
Make it in
Hong Kong
Stop
Making It.

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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 dont 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.

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Style Mean Std Dev
Recommended
Order Quantity
Wholesale
Price
Order
Quantity
Using
Lambda
l
Min
Order
Quantity
Max
Order
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%
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 1,100 762 1,614 123.00 $ 0 0 - 0 35.8%
Electra 2,150 807 2,695 173.00 $ 0 0 - 0 44.2%
Stephanie 1,113 1048 1,819 133.00 $ 0 0 - 0 31.6%
Seduced 4,017 1113 4,767 73.00 $ 0 0 - 0 44.9%
Anita 3,296 2094 4,708 93.00 $ 0 0 - 0 40.3%
Daphne 2,383 1394 3,323 148.00 $ 0 0 - 0 40.8%
10,099
Same Styles Made in Hong Kong
Where to Make What?
That little
cleverness
was worth 2%
Not a big deal. Make
Gail in HK at
minimum

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What Else?
Kais 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.