PRODUCTION AND OPERATIONS MANAGEMENT Vol. 11, No. 3, Fall 2002 Printed in U.S.A.

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT*

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE Department of Management Science and Information Systems, Wright State University, Dayton, Ohio 45435, USA Department of Quantitative Analysis and Operations Management, University of Cincinnati, Cincinnati, Ohio 45221-0130, USA

Customer satisfaction can be achieved by providing rapid delivery of a wide variety of products. High levels of product variety require correspondingly high levels of inventory of each item to quickly respond to customer demand. Delayed product differentiation has been identied as a strategy to reduce nal product inventories while providing the required customer service levels. However, it is done so at the cost of devoting large production capacities to the differentiation stage. We study the impact of this postponement capacity on the ability to achieve the benets of delayed product differentiation. We examine a single-period capacitated inventory model and consider a manufacturing system that produces a single item that is nished into multiple products. After assembly, some amount of the common generic item is completed as non-postponed products, whereas some of the common item is kept as in-process inventory, thereby postponing the commitment to a specic product. The non-postponed nished-goods inventory is used rst to meet demand. Demand in excess of this inventory is met, if possible, through the completion of the common items. Our results indicate that a relatively small amount of postponement capacity is needed to achieve all of the benets of completely delaying product differentiation for all customer demand. This important result will permit many rms to adopt this delaying strategy who previously thought it to be either technologically impossible or prohibitively expensive to do so. (DELAYED PRODUCT DIFFERENTIATION; POSTPONEMENT; FLEXIBLE MANUFACTURING; MASS CUSTOMIZATION)

1. Introduction Companies today have taken the strategic approach of offering a wide variety of customized products to increase customer satisfaction and improve market share. As rms move from mass production to mass customization, they are faced with the challenge of staying cost efcient while providing increased customer satisfaction. Many strategies such as just-in-time and delayed product differentiation have been identied to reduce the nal product inventories typically needed to meet required customer service levels. While we recognize that delaying product differentiation may achieve this goal, it is done so at the cost of devoting large production capacities to this differentiation stage. It is our goal to study the impact of this postponement capacity on the ability to achieve the benets of delayed product differentiation. Our results indicate that a very small postponement capacity is needed to
* Received March 2000; revisions received August 2000, February 2001, and June 2001; accepted June 2001. 340 1059-1478/02/1103/340$1.25
Copyright 2002, Production and Operations Management Society

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT

341

achieve all of the benets of completely delaying product differentiation for all customer demand. This important result will permit many rms who previously thought it either technologically impossible or prohibitively expensive to do so to adopt this delaying strategy. This research also responds to the make-to-stock (MTS) versus make-to-order (MTO) dilemma that many rms face today. As rms investigate production processes they attempt to locate points where the process can switch from push to pull. That is, the points where products can be produced to a generic form and then differentiated only after demand is realized. We assume such points of differentiation exist but investigate an alternative hybrid strategy. We suggest that some inventory be held as nal product and some in generic form. This study was motivated by work with a local manufacturer of non-durable household items. In particular, one product line was differentiated by only the number of units of the item in the package shipped to retailers. We noted large inventory of some packaged products and none of others, while current demand required some of both. In Graman and Magazine (1998), we investigated the impact of waiting until demand was realized before units were packaged. We showed under various conditions, that inventory reductions were possible without deteriorating service rates. In discussion with the rm, however, they indicated that their packaging capacity was not adequate to wait until all of the demand is realized and still meet service-window or lead-time requirements. This led to our hybrid strategy of packaging some products and leaving others in unpackaged bulk storage, which we refer to as partial postponement. Other examples where a combined strategy has proven successful is in computer assembly (Swaminathan and Tayur 1998), the blending of gasoline at the pump, and mixing paint colors at the retail level (Staudt, Taylor, and Bowersox 1976). Several authors have examined the hybrid approach we advocate in this study. Cook (1980) showed that partial postponement of safety stocks at the second echelon resulted in higher customer service levels than either total postponement or total non-postponement. Howard (1994) identied a company that does postponement and also builds speculative inventories to a reduced forecasting window. The use of a hybrid system was considered in Chakravarty (1989), where a rationing policy is shown to have an impact on the required capacity size. Fine and Freund (1990) developed a model that focuses on the economic tradeoffs between the acquisition costs of exible capacity and a rms ability to respond exibly to future uncertain demand. Whitney (1993) described how the requirements of a JIT mixed-model environment can be addressed by exploiting the design process and the assembly process of a family of products. The capability for variety is built into the product rather than depending on the manufacturing system to be exible or recongurable. Eynan and Rosenblatt (1997) consider a single-period model that minimizes total component cost subject to an aggregate service level. Even though a common component can replace unique components in each product, the unique components are used rst. Hillier (1998) considered the possibility of using both cheaper unique parts and a more expensive single common part that can be used as a replacement for any of the unique parts in the event the unique parts stock out. A thorough treatment of quantitative models used in managing product variety can be found in Tayur, Ganeshan, and Magazine (1999). This paper differs from prior work in that our model is not a cost model, but rather an inventory-service-level tradeoff model to study the effects of increasing levels of postponement capacity. We develop a single-period, multiple-product, capacitated postponement model in recognition that total postponement may not be viable because of capacity constraints. The model serves as a basis to identify the fundamental relationships between postponement and the inventory-service-level tradeoff and to assess the impact of different ll rates on inventory level and postponement capacity. In the next section, we develop the model we will use in comparing total inventory for xed service levels and varying postponement capacity. A numerical study and conclusions follow.

342

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE

2. Model Development We consider an existing manufacturing system that produces a single item that is nished into multiple products. In this study, nishing may mean many things, such as assembly, painting, packaging, or delivery. The decision as to which nal products to offer is set by management policy and is exogenous to the model. A decision is made about the inventory levels at the beginning of the period. A single period with a xed length of time was selected to gain a clear understanding of the basic tradeoffs. In addition, many products with short life cycles are amenable to single-period analysis. 2.1. Service Level Measure Achieving customer satisfaction by meeting all demand requires high inventory levels. When all demand is not met customer dis-satisfaction occurs. Stockout cost is one measure of this level of dissatisfaction. However, it is often difcult to determine an exact value for stockout costs. Common substitutes for stockout cost are service level measures (Nahmias 1997, p. 289). Although there are a number of different ways to quantify service levels (Fogarty, Blackstone, and Hoffman 1991), it generally refers to either the probability of not stocking out or the proportion of demand satised directly from the shelf, or ll rate. (Zeng and Hayya 1999, a comparative study of these two measures). It seems appropriate to use ll rate as the service measure in this study because it is generally what most managers mean by service (Nahmias 1997, p. 290). Other aspects and extensions of service levels are discussed in Silver and Peterson (1985). For purposes of this study, lling orders directly from the shelf means that customers expect delivery within some specic amount of time after the order is placed. Meeting the target service level implies that orders are lled within a service window of xed length that is often encountered in practice (Sox, Thomas, and McClain 1997). 2.2. Development of the Capacitated Postponement Model We examine a single-period, m-product inventory model. Figure 1 shows the process ow diagram for the partial-postponement scenario. After assembly, some of the common generic item is completed as non-postponed products and sent to the warehouse to be stored as nished-goods inventory. In addition, some of the common item is kept as in-process inventory, thereby postponing the commitment to a specic product. When demand is realized, some combination of non-postponed and postponed inventories may be used to satisfy the demand.

FIGURE 1. Process Flow Diagram for the Partial Postponement Scenario.

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT

343

The nished-goods inventory of the product is used rst to meet demand. Demand in excess of this inventory is met, if possible, through completion of the common items. It is the capacity of this completion operation that we will refer to as postponement capacity. The level of capacity is set to the number of items that could be completed while still meeting acceptable lead times. Our interest is in setting the non-postponed product inventory levels given a customer service level and to see how this level is affected by the level of postponement capacity. When realized demand exceeds available inventory, an allocation of postponement capacity is made with a goal of equalizing product ll ratesa policy that may lead to non-intuitive stocking policies. It is assumed that the inventory of common items will always be at postponement capacity as this will always result in smaller total inventories for xed service levels (Graman and Magazine 1998). To satisfy a given service-level objective, , it is necessary to obtain an expression for the fraction of demand that stocks out during the period. Let E(SO) represent the expected number of stockouts, and be the expected demand during the period. Then, E SO 1 (1)

If the order-up-to inventory level is chosen so that (1) is satised, the service-level objective will be achieved. In the numerical part of this study, we measure the sensitivity of inventory levels and postponement capacity to different levels of ll rate ranging from 0.800 to 0.999. When the sensitivity of other model parameters is investigated, the target ll rate is set at 0.975, reecting the high ll rate environment of the company that motivated this research. Consider the following partial-postponement scenario: let x j equal the realized demand for product j and SO j equal the number of stockouts for product j. S j is the non-postponed inventory level for product j, and C is the amount of postponement capacity in terms of the common generic item. Let P j be the amount of postponement capacity used to meet the demand for product j such that Pj
j

(2)

Figure 2 is a graphical representation of the inventory levels and possible regions for a two-product partial-postponement scenario where realizations of demand and stockouts occur. This diagram is similar to the one used by Tagaras (1989) in solving a two-location transshipment problem and is similar in structure and interpretation to the diagram used in Fine and Freund (1990) for describing how to optimally allocate scarce capacity in highdemand states based on an expected revenue function. The graph is partitioned into k regions, k 1, . . . , 9. Regions {1} through {6} are dened by boundaries representing the levels of S 1 , S 2 , and C. Regions {7} through {9} are separated by boundaries representing equalization of ll rates. A detailed explanation of the derivation of the algebraic expressions of the boundaries can be found in Appendix A. When demand for both products occurs in a particular region, conclusions about the values of SO j and P j can be made. When demand for both products occurs in region {1}, it is met by S 1 and S 2 . When the demands occur in regions {2}, {3}, or {6}, they are met by S 1 , S 2 , and C, respectively. If the demands occur in region {4}, the demand for product 1 is met from S 1 , while total demand for product 2 is not met because it exceeds the combination of S 2 and C. The converse is true for region {5}. In regions {7}, {8}, and {9} total demand for both products is not met. Total demands in region {7} cannot be met, but capacity can be allocated to equalize the ll rates. Total demands in regions {8} and {9} also cannot be met, and the ll rates cannot be equalized because the demand for one product exceeds the other by more than C.

344

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE

FIGURE 2. Graphical Depiction of Inventory Levels and Regions for a Partial Postponement Scenario Where Realizations of Demand and Stockouts Can Occur.

The expected number of stockouts for product j can be stated by the expression E SO j
k

E SO k

(3)

where E(SO{k} j ) is the expected number of stockouts for product j when demand occurs in region k. A general expression for E(SO{k} j ) in each region k where shortages can occur can be written as E SO k xj Sj Pj f x 1 , x 2 dx 1 dx 2 (4)

Sj P j ) k is the amount of the shortage of product j in region k and f( x 1 , x 2 ) where ( x j is the joint p.d.f. of the random variables of demand X 1 and X 2 for products 1 and 2, respectively. The limits of integration are given in the algebraic expressions for the boundaries of the region of interest and can be found in Appendix A. The left-hand side of (3) is given by (1). The next step is to use this equation to solve for S 1 and S 2 , given the capacity, ll rates, and the demand distributions. We will do this for a variety of scenarios, including different variabilities of demand, various correlations of demand, and the number of products being postponed. The development of a model for more than two products is similar but requires many more regions and does not provide additional insight to the model development process. 2.3. Solution Methodology There is, unfortunately, no simple, closed-form expression for the order-up-to levels in the two-product, capacitated postponement model described in the previous section. An additional difculty lies in the interaction between stocking levels of the non-postponed products and the postponed items. To illustrate this interaction, consider the equation for the expected number of stockouts in region {7} for a two-product model (ref. (A13) and (A14)). Some demand for each product is not met by the non-postponed inventory, and all of the postponement capacity is allocated to equalize the ll rates, i.e., P 1 P2 C. The value

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT

345

of S 1 not only depends on x 1 and P 1 , but also on S 2 , C, and x 2 , which are contained in the limits of integration. The converse is true for S 2 . This complexity and the number of regions in the m-product model led us to develop a stochastic root-nding algorithm that uses a Monte Carlo integration method to determine the appropriate values for the S j s. The algorithm provides the capability to solve the i.i.d. m-product model, as well as two-product models involving different demand distributions and correlated demands by iteratively selecting different values S 1 and S 2 until the right-hand side of (3) is equal to the left-hand side. An explanation of the algorithm is presented in Appendix B. 3. Numerical Results Because we are not able to develop closed-form results, our goal is to gain insights through computational experiments. Rather than doing a full experimental design and statistically attempt to verify hypotheses, our goal of insight development leads us to observations ndings that will be present in most cases although not necessarily true in every instance. Our approach to the problem is best illustrated using a baseline case example. Consider a single-period, two-product system with demands that are i.i.d. N( j , j ) with j 1,000, j 200, j 1, 2, and 0.975. The postponement capacity is set to several different levels. For any level of postponement capacity, the solution to the capacitated postponement model is obtained using the approach described in the previous section to nd the values of S 1 and S 2 required to produce E(SO 1 ) and E(SO 2 ), respectively. Because of the symmetry of the baseline case, the values of S 1 and S 2 will be the same. The parameters and computational results of the baseline case for several levels of postponement capacity are shown in Table 1. The values in the column headed C as a % of E(Demand) can go above 100% because the amount of capacity necessary to have total postponement may exceed the total item expected demand. If C is set so high (note C 2,200) that the service level is exceeded through postponement alone, then S 1 and S 2 will become negative in the model as we attempt to minimize inventories at the target service level. Clearly, negative inventory levels are not possible in practice, and this value of C should never be used. The total inventory required is C S1 S 2. The benet-capacity curve in Figure 3 is a graphical representation of the data in the columns headed Percent Reduction and C as a % of E(Demand) in Table 1. A benets-capacity curve shows the relationship between the benets of postponement, denoted R, and the postponement capacity, denoted C. The benets of postponement are expressed as a percent reduction in nished-goods inventory from zero capacity (non-postponement), and the postponement capacity is expressed as a percent of total expected demand. We nd it convenient to express the benet as a relative measure rather than in absolute quantity of items so that comparisons can be made across different product cases. The solutions to the extreme cases of total non-postponement (capacity 0, inventory 2,311) and total postponement (capacity inventory 2,161) were obtained in Graman and Magazine (1998). The maximum reduction in item inventory level because of postponement, denoted R max, is 6.48%. However, we nd that only a small amount of capacity is needed to realize these benets. Incremental savings are obtained by adding some capacity, but diminish rapidly beyond capacity of approximately 30% of expected demand. Virtually no gains in inventory savings would be realized beyond this point. The amount of capacity needed to realize most of the benets is small relative to total postponement! This is attributed to a reduction in the variance of demand caused by the risk pooling effect that occurs when demand for several items is lled from an inventory of common items. OBSERVATION 1. Only a small amount of postponement capacity is needed to achieve almost all of the benets of postponement. Determination of the point beyond which benets caused by postponement become

346

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE

TABLE 1 Summary of Results for the Baseline Case of Two Products with Independent, Identical-Distributed Normal Demands, N(1,000,200), N(1,000,200) Computational Results C as a % of E(Demand) 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0% 55.0% 60.0% 65.0% 70.0% 75.0% 80.0% 85.0% 90.0% 95.0% 100.0% 105.0% 110.0% Percent Reduction 0.00% 2.83% 4.59% 5.58% 6.08% 6.32% 6.42% 6.46% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48% 6.48%

C 0 100 200 300 400 500 600 700 800 900 1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800 1,900 2,000 2,100 2,200

S1 1,155.67 1,072.81 1,002.23 940.65 884.84 832.14 781.00 730.55 680.41 630.38 580.39 530.40 480.43 430.45 380.47 330.49 280.51 230.53 180.55 130.57 80.60 30.62 19.36

E(SO 1 ) 25.00 25.00 25.00 25.00 25.00 25.01 25.02 25.02 25.01 25.01 25.01 25.01 25.01 25.01 25.01 25.01 25.01 25.01 25.01 25.01 25.01 25.01 25.01

S2 1,155.37 1,072.93 1,002.80 941.45 885.59 832.85 781.66 731.17 680.99 630.92 580.88 530.85 480.83 430.81 380.79 330.77 280.75 230.73 180.71 130.68 80.66 30.64 19.38

E(SO 2 ) 25.00 25.00 25.00 25.00 25.00 24.99 24.98 24.98 24.99 24.99 24.99 24.99 24.99 24.99 24.99 24.99 24.99 24.99 24.99 24.99 24.99 24.99 24.99

S1 2,311.04 2,245.75 2,205.03 2,182.10 2,170.43 2,165.00 2,162.66 2,161.72 2,161.40 2,161.30 2,161.27 2,161.26 2,161.26 2,161.26 2,161.26 2,161.26 2,161.26 2,161.26 2,161.26 2,161.26 2,161.26 2,161.26 2,161.26

S2

marginal depends in part on the cost of postponement. Because costs are not part of this analysis, we arbitrarily dene the point of marginal benet as the amount of capacity required to realize 90% of the maximum benet, denoted C 90%. Ninety percent of R max for the baseline case is equal to 5.83%. The two levels of percent reduction in total nished-goods inventory that bracket 5.83% are 5.58% and 6.08% with associated capacities of 300 and 400 items, respectively (see Table 1). A linear interpolation between the capacities associated

FIGURE 3. Percent Reduction in Item Inventory Versus Capacity as a Percent of Total Item Expected Demand for Two Independent, Identical, Normal-Distributed Products, N(1,000, 200), N(1,000, 200).

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT TABLE 2 Sets of Two Products with Independent and Identically Distributed Demands with Selected Fill Fill Rate 0.800 0.900 0.950 0.975 0.990 0.999 R max 1.80% 3.64% 5.21% 6.48% 7.88% 10.50% C 90% 16.67% 16.72% 17.09% 17.51% 17.99% 20.17%

347

with the bracketed percents gives the capacity of 350.25 items for 5.83%. Division of this amount by the total expected demand (1,000 1,000) gives C 90% 17.51%. We note that a more exact value of C 90% (17.05%) can be found by using a smaller increment of capacity (1 versus 100 units). The difference between these two values of C 90% corresponds to a decrease of approximately 10 units of capacity. We note that interpolation provides conservative estimates of C 90%. The difference between the values is small and does not justify the additional computational effort needed to produce this more exact value of C 90%. 3.1. Fill Rate Because ll rate is a measure of customer satisfaction, we would expect high levels of customer service to require correspondingly high inventory levels. The effect of ll rate on the realization of the benets of postponement at various levels of capacity is examined in this section. Six different levels of ll rate were used in the baseline case. Table 2 and Figure 4 summarize the results of this experiment. Each level of ll rate is shown along with its respective value of R max and C 90%. We observe that R max and C 90% increase in an almostlinear fashion for low ll rates (0.800 0.950) and increase exponentially as ll rate become very high ( 0.950). From these observations we reach the following conclusion: OBSERVATION 2. The benets of postponement increase at an increasing rate as the ll rate increases (the capacity must also increase accordingly to realize any specied benet). This may inuence our choice of the level of customer satisfaction we provide. High levels of satisfaction are possible with a relatively small amount of postponement capacity up to

FIGURE 4. Maximum Benet From Postponement, R max, and the Capacity Required to Realize 90% of the Maximum Benet from Postponement, C 90%, as a Function of Fill Rate.

348

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE TABLE 3 Sets of Two Products with Independent and Identically Distributed Demands with Selected Coefcients of Variation Product Sets c.v. c.v. c.v. c.v. c.v. 0.00 0.10 0.20 0.30 0.40 R max 0.00% 2.69% 6.48% 9.87% 12.60% C 90% 0.00% 9.03% 17.51% 26.02% 34.75%

a point. As we know, lling all customer demands cannot be guaranteed. This presents some measure of making that cutoff. 3.2. Variability of Demand The effect of demand variability on the realization of the benets of postponement at various levels of capacity is examined. Five different levels of the coefcient of variation were selected with js equal to 1,000 among the two-product pairs and different js. Table 3 and Figure 5 summarize the results of this experiment. Each i.i.d. two-product pair along with its corresponding coefcient of variation are shown along with their respective values of Rmax and C90%. We observe that Rmax and C90% increase in an almost-linear fashion as the coefcient of variation increases. From these observations we reach the following observation: OBSERVATION 3. The benets of postponement increase as the coefcient of variation increases (the capacity must also increase to realize any specied benet). The effect of the variability of demand on inventory levels was also analyzed by holding the coefcient of variation constant in 12 sets of two independent, identical products with normal, gamma, and uniformly distributed demands. Each pair differs from every other pair in their respective values of the mean and SD of demand as well as different demand probability distributions. We observe in Figure 6 that the benets of postponement increase at a decreasing rate as the capacity increases. We also note that different levels of demand with the same coefcient of variation generate nearly identical benet-capacity curves that are independent of the demand distributions used in this study. The curves for the gammadistributed pairs are slightly higher than those for the normal and uniform distributions.

FIGURE 5. Percent Reduction in Item Inventory Versus Capacity for Sets of Two Independent, Identical, Normally Distributed Products with Selected Coefcients of Variation.

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT

349

FIGURE 6. Percent Reduction in Item Inventory Versus Capacity for Sets of Two Independent, Identical Products with Normal, Gamma, and Uniformly Distributed Demands and Identical Coefcients of Variation Equal to 0.20.

OBSERVATION 4. The amount of capacity required to realize the benets of postponement is determined overwhelmingly by the coefcient of variation, not by the mean or the SD of demand alone, nor the demand probability distributions considered in this experiment. 3.3. Correlation of Demands We performed experiments to isolate the effect of correlated demands on the realization of the benets of postponement at various levels of postponement capacity. Nine different levels of the correlation coefcient are used in the baseline case. We observe in Figure 7, that for normally distribute demands, R max increases at an increasing rate as the demands become more negatively correlated and C 90% increases at a decreasing rate. These observations lead us to our next nding: OBSERVATION 5. The benets of postponement increase as the demands become more negatively correlated (the capacity required to meet a given benet must also increase to realize those benets). Similar results were obtained for the component commonality problem in Eynan (1996) where the author reports that larger savings result when demands correlation is negative compared with the independent demand case. 3.4. Number of Products Being Postponed We also examine the effect of the number of products being postponed on the realization of the benets of postponement at different levels of postponement capacity. The total

FIGURE 7. Percent Reduction in Item Inventory Versus Capacity for Sets of Two Identical and Normally Distributed Products, N(1,000,200), with Correlated Demands and Seven Different Correlation Coefcients (c.c.).

350

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE

FIGURE 8. Percent Reduction in Item Inventory Versus Capacity for Sets of m-products, Independent and Identically Distributed, N(1,000,200).

expected demand is set at 2,000 items regardless of the number of products being postponed. The number of products ranges from two to ve. We observe in Figure 8, for normally distributed demands, that R max increases at a decreasing rate as the number of i.i.d. products being postponed increases and that C 90% is near constant regardless of the number of products being postponed. These observations lead us to our next insight: OBSERVATION 6. The benets of postponement increase as the number of i.i.d. products being postponed increases; the amount of capacity (as a percent of total expected demand) required to obtain this effect stays constant. 3.5. Non-Identically Distributed Demands To this point, all products being compared were identically distributed. We next want to compare independent but not identically distributed demand for nal products. If only the mean demands are different, E(SO 1 ) E(SO 2 ) and S 1 will not be equal to S 2 . On the other hand, if only the SDs are different, E(SO 1 ) E(SO 2 ) but S 1 may still not be equal to S 2 . The assumption of setting S 1 equal to S 2 for the identically distributed case in the stochastic root-nding algorithm was relaxed. Investigation of non-identically distributed demand will proceed using three approaches: constant coefcient of variation, constant expected demand, and constant SD of demand. 3.5.1. APPROACH 1. CONSTANT COEFFICIENT OF VARIATION. The baseline case is modied with the mean demands ranging from 100 to 1,900 such that 1 2,000. The SDs are chosen 2 so that each product has the same coefcient of variation. Results are obtained for each of the two-product pairs in Table 4. We observe that R max and C 90% increase at a decreasing rate
TABLE 4 Sets of Two Products with Independent and Non-Identically Distributed Demands and Identical Coefcients of Variation Equal to 0.20 Product Sets N(100,20), N(1,900,380) N(200,40), N(1,800,360) N(400,80), N(1,600,320) N(600,120), N(1,400,280) N(800,160), N(1,200,240) N(1,000,200), N(1,000,200) R max 1.03% 2.00% 3.72% 5.10% 6.04% 6.48% C 90% 4.50% 4.86% 9.32% 12.92% 15.24% 17.51%

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT TABLE 5 Sets of Two Products with Independent and Non-Identically Distributed Demands, Identical Expected Demands, and the Sum of the Standard Deviations of Demand Equal to 400 Product Sets N(1,000,0), N(1,000,400) N(1,000,100), N(1,000,300) N(1,000,150), N(1,000,250) N(1,000,200), N(1,000,200) Ratio of 0.000 0.333 0.600 1.000
SD

351

R max 2.92% 4.59% 5.77% 6.48%

C 90% 8.42% 11.28% 14.20% 17.51%

as

gets closer to

2.

We conclude the following:

OBSERVATION 7. The benets of postponement increase as the distribution of demand of one product approaches that of the other; capacity must also increase to realize these benets. It is not surprising that if 2 1 and 2 1 , then larger amounts of non-postponed inventory must be held for product 2 to attempt to equalize ll rates. 3.5.2. APPROACH 2. IDENTICAL EXPECTED DEMANDS. The results of four sets of two-product pairs with 1 1,000 and different j s that sum to 400 were obtained for each entry 2 in Table 5. The ratio of the j s of each two-product pair is shown along with the values of R max and C 90%. We observe that R max and C 90% increase at a near-constant rate as the SD of one product approaches the other. Our conclusion is stated as: OBSERVATION 8. When expected demands are identical, the benets of postponement increase as the SDs of the demands become equal; an increase in capacity is required to realize those benets. An interesting variation of the baseline case is one product with deterministic demand and the other with probabilistic demand. Consider a two-product model with independent and non-identically distributed normal demands with the same means ( 1 1,000), 2 different SDs of demand ( 1 0, 2 400), and 0.975. Figure 9 shows inventory levels for two products at increasing levels of postponement capacity. In the total non-postponement scenario (capacity 0), S 1 and S 2 are found to be equal to 975 and 1,458, respectively, to achieve the required service level for each product. If a policy of postponement is adopted, we would intuitively assume that the nonpostponement inventory of product 1 stays at 975 because its demand is known with certainty. The demand for product 2 (in excess of its non-postponed inventory) would be met

FIGURE 9. Inventory Levels for Two Products with Independent and Non-Identically Distributed Demands, N(1,000,0), N(1,000,400), and Identical Expected Demands.

352

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE TABLE 6 Sets of Two Products with Independent and Non-Identically Distributed Demands, Identical SDs of Demand, and the Sum of the Expected Demands Equal to 2,000 Product Sets N(400,200), N(1,600,200) N(600,200), N(1,400,200) N(800,200), N(1,200,200) N(1,000,200), N(1,000,200)
1

R max 6.61% 6.51% 6.42% 6.48%

C 90% 14.49% 15.30% 16.35% 17.51%

0.250 0.429 0.667 1.000

using the postponement capacity. However, there will be realizations of demand where the demand for product 2 is greater than S 2 , resulting in low ll rates, say 85%, and if the ll rate for product 1 remains at 97.5%, we will not have equal ll rates. In our postponement environment the non-postponement inventory levels are set to equalize the ll rates. The results in Figure 9 show that a target ll rate can be achieved when S 1 (as well as S 2 ) decrease as C increases! A target ll rate can be obtained with less total item (postponed and non-postponed) inventory than would be required in the intuitive non-postponement scenario above. This is one of the consequences of the equal-ll-rate allocation rule we have chosen to adopt. 3.5.3. APPROACH 3. CONSTANT SDS OF DEMANDS. The four sets of two-product pairs in Table 6 have the same SDs of demand and different expected product demands that sum to 2,000. The values of R max and C 90% are shown for each two-product set. We observe that R max is near-constant and C 90% increases slightly at a near-constant rate as the demand of one product approaches the other. We state this nding as follows: OBSERVATION 9. When the SDs of demand are constant, the benets of postponement do not change as the expected demands become equal; however, a slight increase in capacity is required to realize those benets. We make the following conclusion from our analysis of non-identically distributed demands: OBSERVATION 10. The benets of postponement caused by changes in the coefcient of variation are attributed to changes in the SD of demand rather than changes in the expected demand. If the two demands are differently distributed, the benets of postponement will increase as the demand distributions approach each other. 3.6. Summary of Numerical Results The capacitated-postponement model demonstrates that non-postponement requires higher inventory levels than those required for any level of postponement. Stated another way, some benet, in terms of reduced inventory, can be realized from any amount of postponement. Increasing reductions in inventory occur as the ll rate increases, the coefcient of vairation increases, the demands are more negatively correlated, the number of products being postponed increases, and the demand distributions of the products approach each other. The baseline case shows a result that is representative of all the cases studied, i.e., a major portion of the possible benets of postponement are realized at a capacity substantially less than the capacity required for total postponement. Total postponement produces benets that are only marginally better than can be realized at substantially lower capacity levels. This suggests that there may be a level of partial postponement that is at least as benecial as total postponement especially if there is a cost to delaying product differentiation and converting the generic product to a nal product.

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT

353

4. Conclusions A single-period inventory-service-level model was constructed to compare results of different postponement capacity levels. The benet of postponement is dened as the percent reduction in total non-postponed inventory attributed to postponement while the customer service level is held constant. A comparison of the inventory levels required for eah scenario shows that increasing postponement requires less inventory. The main result of this study is that a substantially large portion of the benets of postponement can be realized at capacities far below the capacity required for total postponement. Higher capacities provide virtually no additional benets. Although the benets of postponement increase as the levels of customer satisfaction increase and the model parameters change in the preferred direction, the capacity must also increase to realize those benets. This would have a signicant impact on a rms decision to adopt a postponement strategy and the cost of that adoption. One may envision many environments using postponement with the realization that very little needs to be postponed to gain all of the benets. A similar notion is described in Jordan and Graves (1995), where the authors showed that only a little exibility is needed to achieve almost all the benets of total exibility. In addition, these results suggest that the debate rms have in using a make-to-stock versus a make-to-order strategy may have a simpler answer. Use the hybrid approach and expect no deterioration in service capability, but expect benets in inventory reduction even with a small make-to-order capacity. A strategy relying completely on delayed product differentiation may, in some circumstances, not be as cost effective as the hybrid strategy described in this paper. Also, such a hybrid approach may be superior in some instances to a complete make-to-order or complete make-to-stock inventory strategy. While this study focused on the inventory-service-level tradeoff, further research can be performed on a production cost basis. Given the cost of the postponed item, the cost of the nished product, and the cost to nish the postponed item into the nished good, the total cost at each level of postponement capacity can be determined. The best choice would be the one with the lowest total cost. The impact of the various parameters examined in this study on the optimal combination of postponed and nished inventory could also be investigated. Examples of such a cost structure can be found in Eynan and Rosenblatt (1995) and Hillier (1998). It is worth noting that the choice of the value of these costs could produce different results than those presented in this study. There are issues not addressed in this study that may have a strong inuence on the decision to adopt a postponement strategy. The stage of the product in its life cycle, product characteristics, delivery frequency and delivery time, economies of scale, product/process design, organizational readiness, and barriers between functional areas within the organization are topics that should be given consideration during the decision-making process (Graman 2001).
Appendix A Derivation of Expressions for the Expected Number of Stockouts for the Various Regions in Figure 2 If x 1 S 1 and x 2 S 2 , then the demands occurred in region {1} and were met using the non-postponed inventory of each product. If x 1 S 1 and S 2 x 2 S 2 C, then the demands occurred in region {2}. Demand for product 1 is met from its non-postponed inventory and demand for product 2 is met from its non-postponed inventory plus some amount of the postponement capacity. Conversely, if x 2 S 2 and S 1 x 1 S 1 C, then demands occurred in region {3}. Demand for product 2 is met from its non-postponed inventory, and demand for product 1 is met from its non-postponed inventory plus some amount of the postponement capacity. Expressions for the expected number of stockouts of both products in regions {1}, {2}, and {3} are not necessary because all demands are met. If x 1 S 1 and x 2 S2 C, then the demands occurred in region {4}. Again, the demand for product 1 is met from non-postponed inventory. The demand for product 2 cannot be met using both its non-postponed inventory and all of the postponement capacity. The following expression describes the expected number of stockouts for product 2 in region {4}

354

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE

S1

E SO 4

2 x1 0 x2 S2 C

x2

S2

C f 2 x 2 f 1 x 1 dx 2 d y 1

(A1)

An expression for the expected number of stockouts of product 1 in region {4} is not necessary. Because of symmetry, demands occurring in region {5} are met in the same way as those in region {4} except the references to products 1 and 2 are reversed. x1 S1 S2 C x 2 and S 2 x2 S1 S2 C x 1 , then demands occurred in region {6}. If S 1 Demand for each product are met using all non-postponed inventory and some amount of capacity allocated to each P2 C. Therefore, expressions for the expected number of stockouts of either product in product such that P 1 region {6} are not necessary. If x 1 S1 S2 C x 2 and x 2 S1 S2 C x 1 , then the demands occurred in region {7}, {8}, or {9}. The demands will not be satised and stockouts for both products will occur. All of the non-postponed inventory for each product will be used and all of the postponement capacity will be allocated in some amount, P j , to each product. The goal of equalizing ll rates requires that
1 2

(A2)

where, in these regions, S1

1

P1 x1

(A3)

S2
2

P2 x2

(A4)

and P1 P2 C. (A5)

Combining (A3), (A4), and (A5) yields the following expressions for P 1 and P 2 : P1 C x1 S1 x2 S2 x1 x1 x2 S1 x2 S2 x1 x1 x2 (A6)

P2

C x2

(A7)

Realizations of demand can occur where it is not possible to equalize the ll rates as the demand for one product may be large relative to the other product. Allocation of all the capacity to the large demand product does not raise its ll rate to that of the product with the lower demand. If all of the capacity is allocated to product 2 and none to product 1, where x 2 x 1 , then (A3) and (A4) become S1 x1 (A8)

and S2
2

C x2

(A9)

Equating (A8) and (A9) and solving for x 1 yields x1 S1 S2 C x2 (A10)

If S 1 x1 (S 1 /(S 2 C)) x 2 and x 2 S2 C, the demands occurred in region {8}. Demand is not met for either product. The ll rate of product 1 is greater than the ll rate for product 2, which was allocated all of the capacity. The following expression describes the expected number of stockouts for product 1 in region {8}
S1 / S2 C x 2

E SO 8

1 x2 S2 C x1 S1

x1

S 1 f 1 x 1 f 2 x 2 dx 1 dx 2

(A11)

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT The expected number of stockouts for product 2 in region {8} is E SO 8 x2
x1 S1 x2 S2 C /S1 x1

355

S2

C f 2 x 2 f 1 x 1 dx 2 dx 1

(A12)

The equations for region {9} are the converse of those for region {8}. Regions {6}, {8}, and {9} are bound by region {7}. The total demands in region {7} for both products are not met, and all capacity is allocated to equalize the ll rates. The following expression describes the expected number of stockouts for product 1 in region {7}
S2 C S1 C /S2 x2

E SO 7

1 x2 S2 x1 S1 S2 C x2

x1

S1

P 1 f 1 x 1 f 2 x 2 dx 1 dx 2
S1 C /S2 x2

x1
x2 S2 C x1 S1 / S 2 C x 2

S1

P 1 f 1 x 1 f 2 x 2 dx 1 dx 2

(A13)

The expected number of stockouts for product 2 in region {7} is

S1 C S2 C /S1 x1

E SO 7

2 x1 S1 x2 S1 S2 C x1

x2

S2

P 2 f 2 x 2 f 1 x 1 dx 2 dx 1
S2 C /S1 x1

x2
x1 S1 C x2 S2 / S 1 C x 1

S2

P 2 f 2 x 2 f 1 x 1 dx 2 dx 1

(A14) S2 C

The limits of integration in (A13) and (A14) reect the fact that region {7} is further partitioned at x 2 for product 1 and at x 1 S1 C for product 2 to facilitate the development of the expressions. Appendix B Stochastic Root-Finding Algorithm

We observe in Figure A1 that the expected number of stockouts, E(SO j ), is a decreasing function of the inventory level, S j , for the demand probability distributions used in this study. Therefore, a bisection method will allow us to nd the S j that gives the target E(SO j ). We refer to the procedure as a stochastic root-nding algorithm because it is composed of a bisection routine to nd S j and a Monte Carlo integration method to compute E(SO j ) for given values of S j . Monte Carlo integration (simulation) is a scheme employing random numbers to solve certain stochastic problems where the passage of time plays no substantive role (Law and Kelton 1985, p. 113). Monte Carlo integration evaluates a function at a random sample of points and estimates its integral based on that random sample. The algorithm proceeds as follows: 1. Bisection Method a. Specify the demand distributions, ll rate, and postponement capacity.

FIGURE A1. Expected Number of Stockouts Versus Item Inventory for Three Demand Distributions with Identical Expected Demands and SDs of Demand.

356

GREGORY A. GRAMAN AND MICHAEL J. MAGAZINE

b. Find upper and lower bounds on each S j that produce values for E(SO j ) that are above and below the target E(SO j )s. c. Use a bisection method to converge on the value of S j that meets E(SO j ). 2. Monte Carlo Integration Method a. Generate random variates for each product demand. b. Allocate the postponement capacity using a policy of equalizing ll rates. c. Update the sample statistics on E(SO j ). d. Calculate the condence interval half-width. e. If the calculated half-width is greater that the half-width criterion, go to step 2a. Otherwise, report E(SO j ). 3. If the calculated values of the E(SO j )s are within some of the targeted values of the E(SO j )s, then go to step 4. Otherwise, update the upper and lower bounds on each S j and go to step 1c. 4. Report the S j s.

References
CHAKRAVARTY, A. K. (1989), Analysis of Flexibility with Rationing for a Mix of Manufacturing Facilities, International Journal of Flexible Manufacturing Systems, 2, 1, 43 62. COOK, R. L. (1980), An Examination of Safety Stock Policies in Multi-Echelon Distribution Systems, Ph.D. Thesis, Michigan State University, East Lansing, MI. EYNAN, A. (1996), The Impact of Demands Correlation on the Effectiveness of Component Commonality, International Journal of Production Research, 34, 6, 15811602. AND M. J. ROSENBLATT (1995), Assemble to Order and Assemble in Advance in a Single-Period Stochastic Environment, Naval Research Logistics, 42, 5, 861 872. AND (1997), An Analysis of Purchasing Costs as the Number of Products Components is Reduced, Production and Operations Management, 6, 4, 388 397. FINE, C. H. AND R. M. FREUND (1990), Optimal Investment in Product-Flexible Manufacturing Capacity, Management Science, 36, 4, 449 466. FOGARTY, D. W., J. H. BLACKSTONE, JR., AND T. R. HOFFMAN (1991), Production and Inventory Management, South-Western Publishing Co., Cincinnati, OH, 165172. GRAMAN, G. A. (2001), The Effect of Postponement on a Supply Chain: An Inventory Model and Managerial Implications, Working Paper, Wright State University, Dayton, OH. AND M. J. MAGAZINE (1998), An Analysis of Packaging Postponement, paper presented at the MSOM Conference, University of Washington, Seattle, WA. HILLIER, M. S. (1998), Using Commonality as Backup Safety Stock, Working Paper, University of Washington, Seattle, WA. HOWARD, K. A. (1994), Postponement of Packaging and Product Differentiation for Lower Logistics Costs, Journal of Electronics Manufacturing, 4, 2, 65 69. JORDAN, W. C. AND S. C. GRAVES (1995), Principles on the Benets of Manufacturing Process Flexibility, Management Science, 41, 4, 577594. LAW, A. M. AND W. D. KELTON (1985), Simulation Modeling and Analysis, McGraw-Hill, New York, NY. NAHMIAS, S. (1997), Production and Operations Analysis, Richard D. Irwin. SILVER, E. A. AND R. PETERSON (1985), Decision Systems for Inventory Management and Production Planning, Wiley, New York. SOX, C. R., L. J. THOMAS, AND J. O. MCCLAIN (1997), Coordinating Production and Inventory to Improve Service, Management Science, 43, 9, 1189 1197. STAUDT, T. A., D. A. TAYLOR, AND D. J. BOWERSOX (1976), Marketing Channel Structure, in A Managerial Introduction to Marketing, Prentice-Hall, Englewood Cliffs, NJ. SWAMINATHAN, J. M. AND S. H. TAYUR (1998), Managing Broader Product Lines Through Delayed Product Differentiation Using Vanilla Boxes, Management Science, 44, 12, S161S172. TAGARAS, G. (1989), Effects of pooling on the optimization and service levels of two-location inventory systems, IIE Transactions, 21, 3, 250 257. TAYUR, S. H., R. GANESHAN, AND M. J. MAGAZINE (eds.) (1999), Quantitative Models for Supply Chain Management, Kluwer Academic Publishers, Norwell, MA. WHITNEY, D. E. (1993), Nippondenso Co. Ltd.: A Case Study of Strategic Product Design, Report CSDL-P 3225, C. S. Draper Laboratory, Cambridge, MA. ZENG, A. Z. AND J. C. HAYYA (1999), The Performance of Two Popular Service Measures as Management Effectiveness in Inventory Control, International Journal of Production Economics, 58, 2, 147158.

Gregory A. Graman is an Assistant Professor of Operations Management in the Raj Soin College of Business at Wright State University, where he teaches in the areas of operations management and quantitative analysis. He has a Ph.D. in Operations Management, M.Sc. in Quantitative Analysis, M.B.A. in Operations Management and B.S. in Metallurgical (Material Science) Engineering from the

A NUMERICAL ANALYSIS OF CAPACITATED POSTPONEMENT

357

University of Cincinnati. He has several years of experience in process and industrial engineering, supervision, quality management, and systems analysis in the primary metals industry. He is a member of APICS, holds CPIM certication, and is active in several professional organizations. His current research interests include supply chain management issues, delayed product differentiation, and logistics and distribution systems. Michael J. Magazine is Professor of Quantitative Analysis and Operations Management and Ohio Eminent Scholar. After completing his PhD at the University of Florida in Industrial and Systems Engineering, he taught at North Carolina State University and at the University of Waterloo. In addition, he has had visiting appointments at PUC in Brazil, INRIA in France and Georgia Tech, MIT, and the University of Michigan. He is a Professional Engineer. Professor Magazines research interests include supply chain management, scheduling and other applications of manufacturing systems, especially applied to e-commerce. He has worked on the design and analysis of heuristics and applications in the production and manufacturing area and has been the holder or co-holder of several research grants in this area. He has published over 50 papers in these areas. Professor Magazine has served on the editorial boards of several journals and was the Area Editor of Operations Research for Manufacturing, Operations and Scheduling and is currently a Senior Editor for M&SOM. He is the Co-Editor of Quantitative Models in Supply Chain Management, published by Kluwer in 1999. He has been on the ORSA, TIMS and CORS Councils and has been VP-International for INFORMS and President of the INFORMS Section on Manufacturing and Service Operations Management.