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## What to do with excess clothes (updated)

An interesting story from Reuters. What should retailers do with all of the inventory they had for the spring season?

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## What’s next for just-in-time?

The Financial Times has an interesting set of articles on how the ongoing pandemic impacts supply chains (Trade Secrets: Supply Chain Disruption). These hit on things like toilet paper, firms pivoting to new markets or switching from a business-to-business focus to serving retail customers. The one I want to highlight deals with how any fragility exposed by the pandemic will impact supply chain strategy going forward (Be wary of scapegoating ‘just-in-time’ supply chains, May 27) that links to a post that Gady wrote a few weeks ago.

Here is the gist of the article:

A lot of intellectual momentum is building behind the idea that the Covid-19 pandemic has revealed the foolishness of corporate executives in extending their supply chains without properly assessing the risks. Companies have been thinking of “just-in-time” when they need to be thinking about “just-in-case”. …

The reality is complex, and — a crucial point — differs with each industry. Some, like the car industry, have such sophisticated supply chains involving thousands of different components, some manufactured to extremely low tolerance, that diversifying into different suppliers is totally impractical through effort and cost. Sure, you will have a more resilient supply chain, but you’ll also go bust before the next pandemic arrives.

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## Production planning for the holidays at Lego

This should not surprise you at all: Christmas is a big deal for Lego. According to the Financial Times, half of the company’s sales come in the month or so before the holiday (Lego makes push to avoid disappointments of Christmas past, Dec 22). But how do they gear up for that big peak in sales? Check out the video below:

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## What happens when the World Series results in inventory no one needs?

The World Series starts tonight. While everyone in Chicago is focused on the prospect of the Cubs winning the Series, that is not a certainty. The one thing that is certain is that someone is going to lose – and that raises the prospect of a Cub or Chief Wahoo on t-shirt proclaiming that a team won something that they didn’t.

So what happens to t-shirts and other tchotchkes celebrating events that never happened? That was the topic of a recent Chicago Tribune story (Where do losing baseball teams’ postseason T-shirts end up?, October 18). The article itself is a little confused (it very much seems that a paragraph was dropped) but it does layout some options:

Last year, VF Licensed Sports Group required customers who wanted early access to merchandise celebrating a baseball team’s postseason run agree to ship any merchandise with a losing team’s 2015 MLB postseason clinch logos, images or graphics to international nonprofit World Vision. Customers had 24 hours following a loss to get in touch with World Vision to start the donation process, according to a 2015 agreement provided by a retailer. …

Another retailer was sent a revised agreement that replaced the donation requirement with a mandate to ship any items for losing teams back for destruction. …

Retailers who violate an agreement not to sell, advertise or promote the losing team’s merchandise agree to pay $100,000 per breach, according to the 2016 World Series preprinted merchandise agreement. Read Full Post » ## The Cubs might win: A supply chain story for championship gear For those who are not baseball fans, let me give you a quick update: The Chicago Cubs are really good this year. They won over 100 games in the regular season and have now jumped out to a 2 – 0 lead in their best-of-five series with the San Francisco Giants. FiveThirtyEight has them as the favorite to win the World Series. If all of that is news to you, you should also be told that the Cubs have, frankly, sucked for a long, long time. They haven’t won a pennant since 1945 and a World Series since 1908. There is even a short story (The Last Pennant Before Armageddon) tying the Cubs winning a pennant to the end of the world. (To answer the obvious question, the World Series is scheduled to start on October 25th. Barring rain delays, the last possible game would be on November 2nd. The US presidential election is on November 8th.) So if the Cubs make it to the World Series, there will be a lot of excitement around here. If they actually win the Series, Cook County will likely shut down for a month. And that all raises a question: How many Cubs t-shirts can be sold? Read Full Post » ## Zulily, delivery times, and operations strategy About a year ago, we had a post on Zulily and how they managed their order fulfillment. It featured a nifty graphic from the Wall Street Journal showing just how much longer their delivery times were relative to other interet retailers. Now, the Journal has another story — with a spiffy updated graphic — discussing how their delivery times have gotten even worse (Zulily Nips Business Model in the Bud, Mar 23). Read Full Post » ## Does selling over the web offer better margins than selling in stores? So what should be more profitable for a retailer, selling from physical stores or selling over the web? That’s the question that a recent Wall Street Journal article considers (How the Web Drags on Some Retailers, Dec 1). At first glance, the answer seems straightforward. Web sellers don’t need to rent stores or have staff cooling their heels waiting for customers. However, the reality isn’t necessarily so clear, While conventional wisdom holds that online sales should be more profitable, because websites don’t need the pricey real estate and labor necessary to maintain a store network, many retailers actually earn less or even lose money online after factoring in the cost of shipping, handling and higher rates of returns. For retailers that outsource their Web and fulfillment operations, costs can run as high as 25% of sales, industry analysts said. Kohl’s Corp. says its profitability online is less than half what it reaps in its store. Wal-Mart Stores Inc. says it expects to lose money online at least through early 2016 as it invests to build its technology, infrastructure and fulfillment networks. Target Corp. says its margins will shrink as its online sales grow. Best Buy Co. said faster growth on its website will weigh on its profitability at the end of the year. Click here for a video of the reporter discussing her findings. Read Full Post » ## The impact of pooled inventory on branding risk Shop on Amazon.com and you will find a lot of items sold by lots of different sellers. For many of those sellers, Amazon isn’t just handling acting as a store front; it is also handling the logistics of order fulfillment. Now suppose that Amazon has a particular product which both it and several third parties are selling out its warehouses. How should Amazon physically manage the inventory? Should it keep the inventory it is selling physically separate from that offered by third-party sellers? In many instances, Amazon chooses to do just the opposite, allowing for “stickerless, commingled inventory.” Here is an Amazon video explaining just what that means. And here is how the Wall Street Journal explains the benefits of the program (Do You Know What’s Going in Your Amazon Shopping Cart?, May 11). The system has enabled Amazon to make better use of its warehouse space and keep a wide variety of items in stock around the country. The idea is to give Amazon flexibility to ship certain products based on their proximity to customers, speeding delivery times. For third-party sellers, it saves them the trouble of having to label individual items sent to the Amazon warehouse. Read Full Post » ## A road salt supply chain The weather in Chicagoland over the last week has been miserable. I have shoveled the walks way too many times and it now feels like we’ve been transported to Hoth. That has gotten me thinking about road salt. That and a New Yorker article on the Atlantic Salt’s operations on Staten Island (The Mountain, Dec 23). The mountain referenced in the article’s title is a giant pile of salt — a third of a mile long and four stories high. It’s big enough to see on Google Earth. Check out the multicolored tarps. In any event, managing the inventory of road salt is an interesting challenge. (more…) Read Full Post » ## How do you determine how much money to put into a flexible spending account? It is late October and on my to-do list is wading through Open Enrollment options. That inevitably brings up the question of how much money to put into our Flexible Spending Account (FSA). Given that a lot of people face that question at this time of year, I thought I would recycle a post (from Dec 2011) on how to think of funding an FSA as an inventory problem: FSAs allow US tax payers to set aside pre-tax dollars to pay for authorized expenses. One can have separate accounts for healthcare related expenses (think office-visit co-pays or dental work beyond what your insurance covers) and dependent care. Let’s focus on the medical one. Here is how a Forbes blog explained the pros and cons of the program (A Tax Break For Driving To Wal-Mart!, Dec 2). The way you save with an FSA is this: If you divert$5,000 from taxable salary to pay for braces and your combined federal/state income tax rate is 40%, you save $2,000. You can use the money you stash in the account for medical, dental and vision expenses for yourself, your spouse or your kids. … If you don’t spend your FSA money within the plan year (or a 2.5 month grace period in some cases), you lose it. The fear of forfeiture leads folks to underfund these accounts. Not paying attention to how expansive the list of eligible expenses is leads folks into forfeiting money. The average amount employees set aside into a healthcare flexible spending account is$1,500, and about half of participants lose an average of $75 at year-end, according to WageWorks. But even these employees who forfeit$75 are still better off with the FSA, says Dietel. Since the average election is just under $1,500, the employee has saved 25% to 40% of that, or$375 to $600, so they are still$300 to \$525 ahead of where they would have been without a healthcare FSA.

So here’s the question: Do people, in fact, underfund these accounts?

Let me suggest that a simple inventory problem provides some insights into how much to set aside for an FSA. The newsvendor model assumes that one has a single opportunity to purchase inventory before uncertain demand is realized. The analysis is pretty simple. Suppose that F(x) is the known demand distribution. That is, F(x) gives the probability that demand is less than or equal to x. If we are selling newspapers (which is the motivating example that gives the model its name), F(10) = 60% means that 60% of the time 10 or fewer customers show up to buy papers. Note that F(x) will be increasing (i.e.,the chance that demand is less than or equal 11 has to be greater than the chance that it is less than or equal to 10).

Let Q be the quantity ordered. Let MB be the marginal benefit of stocking one more unit. The relevant thought experiment is to suppose that one stocks Q units but realized demand is Q+1 and ask how much one would have earned if one had had that extra unit to satisfy that last unit of demand. In our newspaper example, suppose they retail for 50¢ but we have to pay the publisher 20¢. We then get MB = 50¢ – 20¢ = 30¢. Similarly let MC be the marginal cost of stocking one more unit. The thought experiment here is to suppose that realized is Q-1. If we can recycle papers at 5¢ a piece, we get MC = 20¢ – 5¢ = 15¢.

The model then says we should balance the expected marginal benefit with equal the expected marginal cost. If we stock Q newspapers, the probability we incur the marginal cost MC is F(Q) and the probability that we receive the marginal benefit MB is (1 – F(Q)). That means we want Q to solve:

MC × F(Q) = MB × (1 – F(Q))

The wonders of junior high algebra then give:

$F(Q) = \frac{MB}{MB+MC}$

In words, we can think of the model as saying that the optimal inventory level is driven by picking a probability of covering all demand. In our newspaper example, we get $\frac{MB}{MB+MC} = \frac{30}{30+15} = 0.66$ so our newsvendor should not stockout (i.e., have newspapers left) on two out of three days.

OK, back to FSAs. Note that we’ve got a one-period inventory model. You decide in October how much to set aside for the coming year and dollars set aside for 2011 cannot be used in 2012. We just need to determine MB and MC. The tricky part here is that we need to be clear of when we are talking about pre-tax dollars and when we are talking about post-tax dollars. Let’s work with pre-tax dollars because that is the amount you specify when you enroll.

MC is then easy. If you put one too many pre-tax dollars into your FSA, you lose that dollar. Thus, MC = 1. For MB, if you are short a dollar in your FSA, you need to spend one post-tax dollar. That costs you $\frac{1}{1 - \tau}$ pre-tax dollars, where τ is your marginal tax rate. The only way to avoid this would have been putting another pre-tax dollar in your FSA (note that this is the analog of paying the publisher for the newspaper). We then get $MB = \frac{1}{1 - \tau} - 1 = \frac{\tau}{1 - \tau}.$

Now we just need to calculate that fraction. The optimal FSA amount should satisfy

$F(Q) = \frac{MB}{MB+MC} = \frac{\frac{\tau}{1 - \tau}}{\frac{\tau}{1 - \tau}+1}= \tau.$

So what do we see? First, not too surprisingly, the marginal tax rate matters a lot. The recommendation is that the tax payer should cover all of her qualifying expenses with probability τ. If her marginal tax rate is very low, say, 10%, she should use all of her FSA contributions nine time out of ten. If τ is very high, say, 90%, she will very often have excess cash in her FSA.

That clearly sounds right. The higher the marginal tax rate, the greater value in paying with pre-tax dollars. Said another way, FSAs have a regressive effect since they provide greater benefit to those in higher tax brackets.

This also lets us answer my original question: Do people, in fact, underfund these accounts? I would argue probably not. Marginal tax rates top out around 40% so even the highest paid Americans should max out their FSAs in most year. Indeed, if half of users end up with excess cash in their FSA (as the quote above suggests), they are putting TOO much money in their FSAs.

There is a caveat to all this analysis. I assuming here that customers are just endowed with some distribution of their spending. To some extent this is true. If you have a chronic condition that requires regular medication, you can forecast your co-pays and then add in kids getting ear infections or needing fillings. That is like forecasting demand for newspapers. However, FSAs also covers spending that is essentially discretionary. If you have a few hundred dollars left in your account in early December, you can always go buy new glasses even if your current ones are fine. Thus, as is pointed out in a recent LA Times article (FSAs encourage rather than reduce unnecessary healthcare spending, Nov 20), FSAs aren’t just regressive, they are inefficient. If one considers people buying unnecessary glasses to clear out their FSA and we still have half of users with leftover cash, then clearly average users are not underfunding their FSAs.

A final point, if you don’t like risk — that is, you would prefer greater certainty in your post-tax income — you may want to put some extra pre-tax dollars in your FSA. See here.

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