Question # 1
The distribution centre will have to pay the penalty for the goods produced but not purchased. For instance, the manufacturer will have to incur a variable cost for additional units produced. Some of the incentives that the distribution centre should be obliged to pay for include variable cost. If the variable cost is $50 per unit, the distributor should pay an extra $50 per additional unit produced.
The manufacturer should also be compensated for the risk factor involved in the production. For instance, if the probability to make a loss is high compared to profit for the additional units, the producer should charge the distributor a penalty equivalent to the risk and strain suffered by the operations management.
Question # 2
a. Average inventory level = (Q/2) + (Safety Stock)
If demand uncertainty is high, the average stock becomes difficult to determine. If the store manager is risk averse, will only keep average inventory level = safety stock. If he is a risk taker will have a high average inventory level to take advantage of immerging demands in the market.
b. Reorder Level = (Average Demand * Lead Time) + (Safety Stock)
If lead time is long, the Reorder Level will be high to avoid stock out before the placed order is received.
c. Order Quantity, Q √ 2 * Average Demand* K ⁄ h
If the ordering cost is high, the order quantity will be high to avoid frequent, costly orders.
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