Morris A. Cohen

Strategic analysis of integrated production-distributed systems: models and methods

This paper presents a comprehensive model framework for linking decisions and performance throughout the material-production-distribution supply chain. The purpose of the model is to support analysis of alternative manufacturing material/service strategies. A series of linked, approximate submodels and an heuristic optimization procedure are introduced. A prototype software implementation is also discussed.

Valuing Operational Flexibility Under Exchange Rate Risk

In this paper, we develop a stochastic dynamic programming formulation for the valuation of global manufacturing strategy options with switching costs. Overall, we adopt a hierarchical approach. First, exchange rates are modeled as stochastic diffusion processes that exhibit intercountry correlation. Second, the firms global manufacturing strategy determines options for alternative product designs as well as supply chain network designs. Product options introduce international supply flexibility. Supply chain network options determine the firms manufacturing flexibility through production capacity and supply chain network linkages. Third, switching costs determine the cost of operational hedging, i.e., the costs associated with reducing downside risks. Overall, the firm maximizes its expected, discounted, global, after-tax value through the exercise of product and supply chain network options and/or through exploitation of operational flexibility contingent on exchange rate realizations. In this environment, the firm must trade off fixed operating costs, switching costs, and the economic benefits derived from exploiting differentials in factor costs and corporate tax rates. A multinomial approximation of correlated exchange rate processes is proposed that leads to a consistent and tractable lattice model for this compound option valuation problem. We then demonstrate how the global manufacturing strategy planning model framework can be utilized to analyze financial and operational hedging strategies.

Performance Contracting in After-Sales Service Supply Chains

Performance-based contracting is reshaping service support supply chains in capital-intensive industries such as aerospace and defense. Known as “power by the hour” in the private sector and as “performance-based logistics” (PBL) in defense contracting, it aims to replace traditionally used fixed-price and cost-plus contracts to improve product availability and reduce the cost of ownership by tying a suppliers compensation to the output value of the product generated by the customer (buyer). To analyze implications of performance-based relationships, we introduce a multitask principal-agent model to support resource allocation and use it to analyze commonly observed contracts. In our model the customer (principal) faces a product availability requirement for the “uptime” of the end product. The customer then offers contracts contingent on availability to n suppliers (agents) of the key subsystems used in the product, who in turn exert cost reduction efforts and set spare-parts inventory investment levels. We show that the first-best solution can be achieved if channel members are risk neutral. When channel members are risk averse, we find that the second-best contract combines a fixed payment, a cost-sharing incentive, and a performance incentive. Furthermore, we study how these contracts evolve over the product deployment life cycle as uncertainty in support cost changes. Finally, we illustrate the application of our model to a problem based on aircraft maintenance data and show how the allocation of performance requirements and contractual terms change under various environmental assumptions.

Performance characteristics of stochastic integrated production-distribution systems

Abstract A conflict often arises between production and marketing or distribution in many firms. Production management would like batch sizes to be large and production smoothed so that additional set-up costs and work force change costs are minimized. Distribution management, on the other hand, would like batch sizes to be small, with frequent changeovers, so that production responds quickly to the changing picture of market demand. It is our purpose in this paper to analyze the management of materials in an integrated supply chain operation. We present a model of a simple integrated production-distribution system and examine its performance characteristics. We present an algorithm for obtaining near-optimal solutions. We limit our examination to a basic single-product, three-location network which consists of a single-station model of a factory, a finished goods stockpile, and a single retailer. This basic network serves to illustrate the key tradeoffs of interest.

Service parts logistics: a benchmark analysis

This paper summarizes the results of a benchmark study focusing on after-sales service logistics systems for technologically complex high-value products, i.e., in the computer industry. Current industrial practices and trends in service logistics operations are reported on. Specific data on costs, revenues, service measures, control policies, and distribution strategies were collected and used to define best practice performance. Analysis methodologies to support cross-sectional comparisons and causal factors are discussed.

Multiproduct integrated production--distribution systems

Abstract In many firms the goals of the production staff are in conflict with those of the marketing staff. Often the resolution of the conflicting goals is to require a stockpile of finished goods to hold large amounts of inventory. The two functional areas thus are buffered. It is our opinion that an integrated view of the entire production-distribution system may generate significant savings by trading off the costs associated with the whole, rather than minimizing production and distribution costs separately. In this paper we develop a model of an integrated production-distribution system comprised of a single station model of a factory, a stockpile of finished goods, and a single retailer. The concepts and solution methodology, however, show promise for more complex networks. Multiple products with stochastic, independent demand are produced at the factory, stored at FG, and distributed to the retailer where demand is met or backlogged. In addition, FG may order an expedite batch of a particular product if its stock level decreases to a specified expedite reorder point. Expedite batches have nonpreemptive priority over normal replenishment batches. We approximate the distributions of key random variables to compute costs and service levels for all products across the supply chain. We find that our approximations are often quite accurate. Our limited tests of the performance of the near-optimization algorithm indicate that it provides solutions very close to the optimal. We also provide results that yield insight into the behavior of this integrated system.

Impact of Performance-Based Contracting on Product Reliability: An Empirical Analysis

Using a proprietary data set provided by a major manufacturer of aircraft engines, we empirically investigate how product reliability is impacted by the use of two different types of after-sales maintenance support contracts: time and material contracts (T&MC) and performance-based contracts (PBC). We offer a number of competing arguments based on the theory of incentives that establish why product reliability may increase or decrease under PBC. We build a two-stage econometric model that explicitly accounts for the endogeneity of contract choices, and find evidence of a positive and significant effect of PBC on product reliability. The estimation of our model indicates that product reliability is higher by 25%--40% under PBC compared to under T&MC, once the endogeneity of contract choice is taken into account. Our results are consistent with two mechanisms for reliability improvement under PBC: more frequent scheduled maintenance and better care performed in each maintenance event. This paper was accepted by Martin Lariviere, operations management.

Analysis of Single Critical Number Ordering Policies for Perishable Inventories

We consider the problem of finding the optimal solution from the class of single critical number order policies for an m-period lifetime perishable product. The objective function is expected cost per period, Accordingly, the steady-state characteristics of the inventory process induced by the order restriction are analyzed. We demonstrate the existence of an invariant measure for an inventory related process, which provides information sufficient for cost minimization. Particular results for the two-and three-period-lifetime cases are given.

An integrated plant loading model with economies of scale and scope

Abstract This paper presents a new formulation of a class of plant product mix-loading problems which are characterized by fixed facility costs, concave production costs and an integrated network structure which encompasses inbound supply and outbound distribution flows. In particular, we are interested in assigning product lines and volumes to a set of capacitated plants. Fixed costs are incurred when a product line is assigned to a plant. The production cost function also exhibits concavity with respect to each product line volume. Thus both scale and scope economies are considered explicitly in the model. The problem formulation leads to a concave mixed-integer mathematical program. We develop an optimization algorithm within the framework of Benders decomposition for the case of a piecewise linear concave cost function. Our algorithm generates optimal solutions efficiently. The problem solutions also illustrate how our model is effective in evaluating tradeoffs between inbound, production and outbound costs. Finally the model is used to illustrate the impact of various cost factors (logistics, scale and complexity) on optimal product mix solutions.

An analytical comparison of long and short term contracts

In this paper, we describe an analytical model to determine contracting policies for a firm that purchases components from external suppliers. The model evaluates the tradeoff between the flexibility offered by short term contracts and the fixed investments, improvement opportunities and price certainty associated with long term contracts. We show that long term contracts may not always be optimal, and discuss conditions under which short term contracts may be justified. During a recent survey of supply managers, we observed that managers often tend to participate in short term contracts, even though they claim to seek long term relationships with suppliers. Sensitivity analysis of our model provides some explanation for this observed inconsistency. We also discuss managerial implications of the analysis.