MSOM, Spring 2012

Capacity Planning in the SemiconductorIndustry: Dual-Mode Procurement with Options

To help a firm reduce inefficienciesassociated with equipment capacity planning, we propose a dual-mode equipmentprocurement (DMEP) framework. DMEP combines dual-source (i.e., aless-expensive-but-slower base mode and a faster-but-more-expensive flexiblemode) procurement with option contracts in three layers: a contract negotiationlayer, where the firm chooses the best combination of lead time and price foreach mode from the supply contract menu; a capacity reservation layer, wherethe firm reserves total equipment procurement quantities from the two supplymodes before the planning horizon starts; and an execution layer, where the firmorders equipment from the two supply modes based on the updated demandinformation. We first investigate the execution layer as a dynamic dual-sourcecapacity expansion problem with demand backlogging and demonstrate that theoptimal policy lacks structure even under the simplest setting. Thus, wepropose a heuristic solution for the execution-layer problem, which also servesas a building block for the other two layers. Through numerical analysis, wequantify the value of the added flexibility of DMEP for the firm. The DMEPframework has been implemented at Intel Corporation and has resulted in savingsof tens of millions of dollars for one process technology.

Operational Compliance Levers,Environmental Performance, and Firm Performance Under Cap and Trade Regulation

Cap and trade programs impose limits onindustry emissions but offer individual firms the flexibility to choose amongdifferent operational levers toward compliance, including inputs, processchanges, and the use of allowances to account for emissions. In this paper, weexamine the relationships among (1) levers for compliance (at-source pollutionprevention, end-of-pipe pollution control, and the use of allowances); (2)environmental performance; and (3) firm market performance for the context ofstringent cap and trade regulation with allowance grandfathering (i.e., theallocation of allowances for free). To investigate these relationships, we usedata on publicly traded utility firms operating coal-fired generating unitsregulated by the U.S. Acid Rain Program from three principal sources: the U.S.Energy Information Administration, the U.S. Environmental Protection Agency,and the Compustat database. Our results indicate a significant relationshipbetween better environmental performance and lower firm market performance overat least a three-year period. From a regulatory perspective, our results show anegative association between allowance grandfathering and firm environmentalperformance. Overall, by explicitly considering the context of stringentregulation, we find a counter-example to the view that better environmentalperformance generally associates with better economic performance.

Using a Dual-Sourcing Option in thePresence of Asymmetric Information About Supplier Reliability: Competition vs.Diversification

We study a buyer's strategic use of adual-sourcing option when facing suppliers possessing private information abouttheir disruption likelihood. We solve for the buyer's optimal procurementcontract. We show that the optimal contract can be interpreted as the buyerchoosing between diversification and competition benefits. Better informationincreases diversification benefits and decreases competition benefits.Therefore, with better information the buyer is more inclined to diversify.Moreover, better information may increase or decrease the value of thedual-sourcing option, depending on the buyer's unit revenue: for large revenue,the buyer uses the dual sourcing option for diversification, the benefits ofwhich increase with information; for small revenue, the buyer uses the dualsourcing option for competition, the benefits of which decrease withinformation. Surprisingly, as the reliability of the entire supply basedecreases, the buyer may stop diversifying under asymmetric information (toleverage competition), whereas it would never do so under symmetricinformation. Finally, we analyze the effect of codependence between supplydisruptions. We find that lower codependence leads the buyer to rely less oncompetition. Because competition keeps the information costs in check, areduction in supplier codependence increases the buyer's value of information.Therefore, strategic actions to reduce codependence between supplierdisruptions should not be seen as a substitute for learning about suppliers'reliabilities.

Are Reservations Recommended?

We examine the role of reservations incapacity-constrained services with a focus on restaurants. Although customersvalue reservations, restaurants typically neither charge for them nor imposepenalties for failing to keep them. However, reservations impose costs on firmsoffering them. We offer a novel motivation for offering reservations thatemphasizes the way in which reservations can alter customer behavior. We focuson a market in which demand is uncertain and the firm has limited capacity.There is a positive chance that the firm will not have enough capacity to serveall potential customers. Customers are unable to observe how many potentialdiners are in the market before incurring a cost to request service. Hence, ifreservations are not offered, some may choose to stay home rather than riskbeing denied service. This lowers the firm's sales when realized demand is low.Reservations increase sales on a slow night by guaranteeing reservationsholders service. However, some reservation holders may choose not to use theirreservations resulting in no-shows. The firm must then trade off higher salesin a soft market with sales lost to no-shows on busy nights. We consequently evaluatevarious no-show mitigation strategies, all of which serve to make reservationsmore likely in equilibrium. Competition also makes reservations moreattractive; when there are many small firms in the market, reservations arealways offered.

Optimizing Organic Waste to EnergyOperations

A waste-to-energy firm that recyclesorganic waste with energy recovery performs two environmentally beneficialfunctions: it diverts waste from landfills and it produces renewable energy. Atthe same time, the waste-to-energy firm serves and collects revenue from twotypes of customers: waste generators who pay for waste disposal service andelectricity consumers who buy energy. Given the process characteristics of thewaste-to-energy operation, the market characteristics for waste disposal andenergy, and the mechanisms regulators use to encourage production of renewableenergy, we determine the profit-maximizing operating strategy of the firm. Wealso show how regulatory mechanisms affect the operating decisions of the waste-to-energyfirm. Our analyses suggest that if the social planner's objective is tomaximize landfill diversion, offering a subsidy as a per kilowatt-hour forelectricity is more cost effective, whereas if the objective is to maximizerenewable energy generation, giving a subsidy as a lump sum to offset capitalcosts is more effective. This has different regulatory implications for urbanand rural settings where the environmental objectives may differ.

Unit-Contingent Power Purchase Agreementand Asymmetric Information About Plant Outage

This paper analyzes a unit-contingent powerpurchase agreement between an electricity distributor and a power plant. Undersuch a contract the distributor pays the plant a fixed price if the plant isoperational and nothing if plant outage occurs. Pricing a unit-contingentcontract is complicated by the fact that the plant's true status is its privateinformation. The difference between the electricity spot price and theunit-contingent contract price provides an incentive for the plant to misreportits status and earn profit at the distributor's expense. To preventmisreporting, the distributor may inspect the plant and levy penalties ifmisreporting is discovered. We find that some type of misreporting undercertain circumstances can benefit both the plant and the distributor, becauseit serves as a risk-allocation mechanism between the two parties. We show thatsuch a risk-allocation mechanism is equivalent to using state-contingentoptions and prohibiting misreporting.

The Impact of Dependent Service Times onLarge-Scale Service Systems

This paper investigates the impact ofdependence among successive service times on the transient and steady-stateperformance of a large-scale service system. This is done by studying aninfinite-server queueing model with time-varying arrival rate, exploiting arecently established heavy-traffic limit, allowing dependence among the servicetimes. This limit shows that the number of customers in the system at any timeis approximately Gaussian, where the time-varying mean is unaffected by thedependence, but the time-varying variance is affected by the dependence. As aconsequence, required staffing to meet customary quality-of-service targets ina large-scale service system with finitely many servers based on a normalapproximation is primarily affected by dependence among the service timesthrough this time-varying variance. This paper develops formulas and algorithmsto quantify the impact of the dependence among the service times on thatvariance. The approximation applies directly to infinite-server models but alsoindirectly to associated finite-server models, exploiting approximations basedon the peakedness (the ratio of the variance to the mean in the infinite-servermodel). Comparisons with simulations confirm that the approximations can beuseful to assess the impact of the dependence.

Optimal Algorithms for Assortment SelectionUnder Ranking-Based Consumer Choice Models

A retailer's product selection decisionsare largely driven by her assumptions on how consumers make choices. We use aranking-based consumer choice model to represent consumer preferences: everycustomer has a ranking of the potential products in the category and purchaseshis highest ranked product (if any) offered in the assortment. We consider fourpractically motivated special cases of this model, namely, the one-waysubstitution, the locational choice, the outtree, and the intree preferencemodels, and we study the retailer's product selection problem when productshave different price and cost parameters. We assume that the retailer incurs afixed carrying cost per product offered, a goodwill penalty for each customerwho does not purchase his first choice and a lost sale penalty for eachcustomer who does not find an acceptable product to buy. For the first threemodels, we obtain efficient solution methods that simplify to either a shortestpath method or a dynamic program. For the fourth model, we construct aneffective algorithm and show numerically that, in practice, it is much fasterthan enumeration. We also obtain valuable insights on the structure of theoptimal assortment.

In-Season Transshipments Among CompetitiveRetailers

A decentralized system of competingretailers that order and sell the same product in a sales season is studied.When a customer demand occurs at a stocked-out retailer, that retailer requestsa unit to be transshipped from another retailer who charges a transshipmentprice. If this request is rejected, the unsatisfied customer may go to anotherretailer with a customer overflow probability. Each retailer decides on theinitial order quantity from a manufacturer and on the acceptance/rejection ofeach transshipment request. For two retailers, we show that retailers' optimaltransshipment policies are dynamic and characterized by chronologicallynonincreasing inventory holdback levels. We analytically study the sensitivityof holdback levels to explain interesting findings, such as smaller retailersand geographically distant retailers benefit more from transshipments.Numerical experiments show that retailers substantially benefit from usingoptimal transshipment policies compared to no sharing. The expected salesincrease in all but a handful of over 3,000 problem instances. Building on thetwo-retailer optimal policies, we suggest an effective heuristic transshipmentpolicy for a multiretailer system.

Managing Opportunistic Supplier ProductAdulteration: Deferred Payments, Inspection, and Combined Mechanisms

Recent cases of product adulteration byforeign suppliers have compelled many manufacturers to rethink approaches todeterring suppliers from cutting corners, especially when manufacturers cannotfully monitor and control the suppliers' actions. In this paper, we study threemechanisms for dealing with product adulteration problems: (a) the deferredpayment mechanism—the buyer pays the supplier after the deferred payment periodonly if no adulteration has been discovered by the customers; (b) theinspection mechanism—the buyer pays the supplier immediately, contingent onproduct passing the inspection; and (c) the combined mechanism—a combination ofthe deferred payment and inspection mechanisms. We show that the inspectionmechanism cannot completely deter the suppliers from product adulteration,whereas the deferred payment mechanism can. Surprisingly, the combinedmechanism is redundant: either the inspection or the deferred paymentmechanisms perform just as well. Finally, we identify four factors thatdetermine the dominance of deferred payment mechanism over the inspectionmechanism: (a) the inspection cost relative to inspection accuracy, (b) thebuyer's liability for adulterated products, (c) the difference in financingrates for the buyer and the supplier relative to the defects discovery rate bycustomers, and (d) the difference in production costs for adulterated andunadulterated product. We find that the deferred payment mechanism ispreferable to inspection if the threats of adulteration (either incentive toadulterate or the consequences) are low.

Key Factors in the Market forRemanufactured Products

Measures to extend the economic lives ofproducts—such as remanufacturing carried out by closed-loop supply chains—arereceiving increased attention because of various economic and regulatoryfactors. In this paper, we examine drivers of price differentials between newand remanufactured products using data on purchases made on eBay. Our analysisshows that seller reputation significantly explains the price differentialsbetween new and remanufactured products. We also find that productsremanufactured by original equipment manufacturers or their authorizedfactories are purchased at relatively higher prices than productsremanufactured by third parties. However, in the presence of these reputationsignals (seller reputation and remanufacturer identity), we find that strongerwarranties are not significantly associated with higher prices paid forremanufactured products. Our work contributes to the closed-loop supply chainresearch stream in operations management by empirically examining marketfactors that have not been studied before.

Supply Chain Dynamics and ChannelEfficiency in Durable Product Pricing and Distribution

This study extends the single-periodvertical price interaction in a manufacturer–retailer dyad to a multiperiodsetting. A manufacturer distributes a durable product through an exclusiveretailer to an exhaustible population of consumers with heterogeneousreservation prices. In each period, the manufacturer and retailer in turn setwholesale and retail prices, respectively, and customers with valuation abovethe retail price adopt the product at a constant (hazard) rate. We derive theopen-loop, feedback, and myopic equilibria for this dynamic pricing game andcompare it to the centralized solution. Although in an integrated supply chaina forward-looking dynamic pricing strategy is always desirable, we show thatthis is not the case in a decentralized setting, because of verticalcompetition. Our main result is that both supply chain entities are better offin the long run when they ignore the impact of current prices on future demandand focus on immediate-term profits. A numerical study confirms that thisinsight is robust under various supply- and demand-side effects. We use thechannel efficiency corresponding to various pricing rules to further deriveinsights into decisions on decentralization and disintermediation.