Chapter 6 Designing Global Supply Chain Networks 171 CASE STUDY The Sourcing Decision at Forever Young in the United States. The company divides the year into Forever Young is a retailer of trendy and low-cost apparel 1,040 units, Forever Young will sell 1,040 units. How- ever, if demand turns out to be lower than 1,040, the a new merchandise for each season. The company has four sales seasons of about three months each and brings company will have leftover product for which it will not historically outsourced production to China, given the be able to recover any revenue. The short lead time of the local supplier allows costs 55 yuan/unit (inclusive of all delivery costs), which lower costs there. Sourcing from the Chinese supplier Forever Young to keep bringing product in a little bit at a time, based on actual sales. Thus, if the local supplier is at the current exchange rate of 6.5 yuan/s gives a vari used, the company is able to meet all demand in each able cost of under $8.50/unit. The Chinese supplier. period without having any unsold inventory or lost sales however, has a long lead time, forcing Forever Young to in other words, the final order from the local supplier will pick an order size well before the start of the season. exactly equal the demand observed by Forever Young This does not leave the company any flexibility if actual demand differs from the order size. A Potential Hybrid Strategy A local supplier has come to management with a proposal to supply product at a cost of $10/unit but to do The local supplier has also offered another proposal that so quickly enough that Forever Young will be able to would allow Forever Young to use both suppliers, each make supply in the season exactly match demand. Man playing a different role. The Chinese supplier would pro- agement is concerned about the higher variable cost but duce a base quantity for the season and the local supplier finds the flexibility of the onshore supplier very attrac- would cover any shortfalls that result. The short lead tive. The challenge is to value the responsiveness pro- time of the local supplier would ensure that no sales are vided by the local supplier. lost. In other words, if Forever Young committed to a base load of 900 units with the Chinese supplier in Uncertainties Faced by Forever Young a given period and demand was 900 units or less, noth- ing would be ordered from the local supplier. If demand, To better compare the two suppliers, management identi however, was larger than 900 units (say, 1.100), the fies demand and exchange rates as the two major uncer shortfall of 200 units would be supplied by the local sup- inties faced by the company. Over each of the next two plier. Under a hybrid strategy, the local supplier would periods (assume them to be a year each), demand may go end up supplying only a small fraction of the season's up by 10 percent, with a probability of 0.5, or down by 10 demand. For this extra flexibility and reduced volumes percent, with a probability of 0.5. Demand in the current however, the local supplier proposes to charge $11/unit period was 1,000 units. Similarly, over each of the next two if it is used as part of a hybrid strategy. periods, the yuan may strengthen by 5 percent, with a prob- ability of 0.5, or weaken by 5 percent, with a probability of Study Questions 0.5. The exchange rate in the current period was 6.5 years. 1. Draw a decision tree reflecting the uncertainty over the Ordering Policies with the Two Suppliers next two periods. Identify each node in terms of demand and exchange rate and the transition probabilities. Given the long lead time of the offshore supplier, For 2. If management Forever Young is to pick only one of the ever Young commits to an order before observing any two suppliers, which one would you recommend? What is demand signal. Given the demand uncertainty over the the NPV of expected profit over the next two periods for each of the two choices? Assume a discount factor of next two periods and the fact that the margin from each unit (about $11.50) is higher than the loss if the unit 0.1 per period remains unsold at the end of the season (loss of about 3. What do you think about the hybrid approach? Is it worth paying the local supplier extra to use it as part of a hybrid $8.50), management decides to commit to an order that strategy for the hybrid approach, assume that manage- Is somewhat higher than expected demand. Given that ment will order a base load of 900 units from the Chinese expected demand is 1.000 units over each of the next supplier for each of the two periods, making up any short fall in cach period of the local supplier Evaluate the NPV from the Chinese supplier for each of the next two peri- of expected profits for the hybrid option assuming a dis- count factor of 0.1 per period. o periods, management decides to order 1,040 units ods. If demand in a period turns out to be higher than