Class 14: Risk Pooling

BUSSCM1730: MGSC Final, Prof. Aflaki

Objective of Risk Pooling

• To REDESIGN the supply chain, the production process or the product to either reduce the uncertainty the firm faces or to hedge uncertainty so that the firm is in a better position to mitigate the consequence of uncertainty

Coefficient of Variation 

• An important measure of uncertainty and captures the size of uncertainty relative to demand, the ratio of the standard deviation to the mean (Cv = SD/mean)

• A higher value of cv signals a more uncertain demand 

• At any given service level: less variable demand → less inventory! 

Demand Distribution in Pooled System 

• Same mean and standard deviation pooling two regions - KNOW FORMULAS!

• For each decentralized region - KNOW FORMULA! 

• CV is lower for the pooled system! 

CV in Pooled System

• Demand in the pools system is relatively less variable 

• As the correlation increases, CV in the pooled system increases and there is less value in pooling locations 

Mean & SD in Pooled System 

• If n locations have INDEPENDENT demands (p = 0) with mean and standard deviation are pooled together, the pooled demand is – KNOW FORMULAS! 

• If all locations have the same mean and standard deviation then the pooled demand has – KNOW FORMULAS! 

Impact of Pooling on Inventory Costs 

• Since CV is lower under the pooled system, HOLDING COST is associated with inventory tends to be LOWER

• The value of pooling INCREASES as MORE regions are pooled together 

• Most online retailers exploit the benefits of aggregation to reduce inventory

Disadvantages of Location Pooling

• Pooling location may INCREASE response time to customer order 

• Pooling location may INCREASE the transportation costs 

Solutions to Pooling

Using solutions like information centralization, specialization, product substitution, component commonality, and postponement

Information Centralization 

• Online systems that allow customers or stores to locate stocks 

Specialization 

• Should all products be stocked in every location? 

• The decision depends on the CV of demand! 

  • LOW demand (SLOW-MOVING) items → have HIGHER CV → stocked at CENTRALIZED locations 

  • HIGH demand (FAST-MOVING) items → have LOW CV → stocked at DECENTRALIZED locations 

• The value and cost of the product should also be considered! 

  Product substitution

• The use of one product to satisfy demand for a different product 

Component commonality 

• Without common components

  • Uncertainty of demand for a component is the SAME as for the finished product 

  • Results in HIGH levels of safety inventory 

• With common components

  • Demand for a common component is an aggregation of the demand for the finished products 

  • Component demand is MORE predictable 

  • Component inventories are REDUCED

Postponement 

• Delay product differentiation or customization until closer to the time the product is sold

Push

• Have common components in the supply chain for most of the _______ phase 

Pull

• Move product differentiation as close to the ______ phase of the supply chain as possible