Risk hedging methods in OM,He Xu School of management, Huazhong University of Science and Technology,2,Agenda,The effect of risk pooling Risk pooling strategies Paper discussions,3,Risk pooling effect,Risk pooling, or statistical economies of scale, is a pervasive phenomenon which underlies major economic activities such as banking and insurance. In operations management, it is often achieved by consolidating a product with a random demand into one location, which is known to be beneficial.,4,Risk pooling strategies,Supply- side Centralization of inventory Delayed differentiation Component commonality Product substitution Flexible capacity,5,Risk pooling strategies,Demand- side Demand postponement Demand reshape Responsive pricing,6,Centralization of inventory,Gary D. Eppen (1979) “Effects of Centralization on Expected Costs in a Multi-Location Newsboy Problem” Management Science, Vol. 25, No. 5, pp. 498-501,7,Research findings,The expected holding and penalty costs in a decentralized system exceed those in a centralized system. The magnitude of the saving depends on the correlation of demands. If demands are identical and uncorrelated, the costs increase as the square root of the number of consolidated demands.,8,Delay differentiation,Purchasing postponement Delay purchasing of some expensive and fragile materials Manufacturing postponement Benetton reengineered the production of knitted sweaters so that the dyeing became one of the last stages of the production process Logistics postponement Products in semi-finished forms and can be customized quickly in production facilities close to customers Time postponement Finished products are kept in central location and distributed quickly to customers,9,Component commonality and product substitution are risk pooling methods before or after the final product is produced. Component commonality MARK S. HILLIER(2000) “Component commonality in multiple-period, assemble-to-order systems” product substitution He Xu, David Yao and Shaohui Zheng(2008) “Optimal Policies for a Two-Product Inventory System under a Flexible Substitution Scheme”, “Optimal Control of Replenishment and Substitution in an Inventory System with Nonstationary Batch Demand”,10,Flexible capacity,A flexible resource can be used to satisfy distinct demand classes AAI will have the ability to change the mix, volume and options of products-all with minimal investment and changeover loss Ford expects to save up to 2 billion because its flexible system will cost 10 percent to 15 percent less than traditional systems, with an added 50 percent savings in changeover costs By mid-decade in North America, about half of Fords body shops, trim and final assembly operations will be flexible,11,Demand postponement,Under demand postponement, a fraction of the demands from the “regular” period are postponed and satisfied during a “postponement” period. Ananth V. Iyer, Vinayak Deshpande, Zhengping Wu (2003) ”A Postponement Model for Demand Management” Management Science. Vol. 49, No. 8, pp. 9831002,12,Examples,Consider the problem faced by a manager of an electrical grid (supplier) that supplies industrial customers. The supplier has to plan for short-term capacity (e.g., supply for an eight-hour block of a day on a repetitive basis). The supplier uses his forecast of demand to buy capacity at a pre specified unit price in advance of this time block.,13,If the demand for this time block falls short of capacity, the supplier will have unused capacity for which he is already committed. However, if the demand for this time block exceeds the committed capacity, the supplier has to buy extra capacity from the spot market at a much higher price to satisfy demand. At the beginning of this time block, based on the revised forecast, he can contact his industrial customers and get them to “postpone demand” to a later time in return for a reimbursement per unit postponed.,14,15,Research findings,The value of postponement may be significant depending on cost and demand parameters. A postponement strategy may lead to reduced investment in initial capacity. It may be optimal to do no demand postponement over a range of demands even after observing a higher demand signal.,16,17,18,Why not utilize the demand postponement even after observing a higher demand signal?,19,Demand reshape,This reshaping is obtained by making an effort to persuade some of the customers to purchase another (usually a substitute) item instead of the original item they had in mind. The cost of such effort can vary widely, and can be as minimal as displaying posters in the store to make customers more aware of the available substitute item.,20,Amit Eynan, Thierry Fouque (2003) ”Capturing the Risk-Pooling Effect Through Demand Reshape”. Management Science . Vol. 49, No. 6, pp. 704717,21,22,23,24,Responsive pricing,With responsive pricing, a firm can influence the demand for its output by setting prices according to the actual demand conditi