Specialty_Toys_Case

November 10, 2010 Professor Chen Katelyn Wilkins Specialty Toys Managerial Report Specialty Toys is faced with the decision of having to decide how many units of Weather Teddy should be purchased in order to meet the sales demand. The company must decide on the best forecasted quantity so that market demand is able to be met without merchandise shortages but without purchasing too much of the product and risking excess inventory and consequently, reduced profits. Management has recommended varying order quantities, or decision alternatives, of 15,000, 18,000, 24,000, and 28,000, indicating that there is a disagreement over what the market demand for Weather Teddy will be for the upcoming holiday season. Each alternative needs to be measured against three possible scenarios for market demand; worst case of 10,000 units, most likely case of 20,000 units, and best case of 30,000 units. Assuming a sales price of $24 and a cost of $16 for Weather Teddy, plus an inventory sales price of $5, profit under each scenario will be calculated for each decision alternative. Specialty’s Senior Forecasted has predicted that the average demand will be 20,000 units and is 95% confident that demand will be between 10,000 and 30,000 units. After completing analytics based on the above statistics provided by management and the Senior Forecaster, we have concluded the following: * Assuming an average (mean) demand of 20,000 units there is a demand variability of about +/-5,100 units from the average, given that there is a 95% chance that the demand will between 10,000 and 30,000 units. Please refer to Appendix Chart #1 for a graphical representation of the demand probabilities. * The probability that a stock-out will occur for each of management’s recommended demand quantities logically decreases with the increasing quantities. For instance, the chance that a stock-out will occur when the order quantity is 15,000 is 83.7% and the chance that a stock-out will occur when the order quantity is 28,000 is 5.9%. The more Weather Teddy’s ordered, the more likely we are to meet customer demand this holiday season. Please refer to Appendix Chart #2 for the probabilities of a stock-out at each quantity demand. * However, this is not to say that accepting the largest quantity demand is the most profitable decision. There is a cost, or lost profit associated with having excess inventory on-hand. Specialty must sell the product at a discounted price of $5 per unit, which is an $11 loss per unit that is in excess of market demand. The attached profitability chart (Appendix Chart #3) shows the profit per decision alternative under 3 different scenarios (worst case, most likely, best case). While ordering 15,000 units of Weather Teddy guarantees the company earn a profit under any scenario, we will not capture the higher profits earned at larger quantities because we are far more likely to incur a stock-out. An order quantity that balances the risk of a loss and a solid profit is what we should attain. * Per Management, the profit potential is so great such that the order quantity should have a 70% chance of meeting demand and a 30% chance of a stock-out. Under this policy, the quantity that should be ordered is 22,423 units of Weather Teddy. Under each of the demand scenarios, the loss incurred under the worst case scenario is $56,658, the profit under the most likely scenario is $133,342 and the profit under the best case scenario is $179,388. Appendix Chart #4. * My recommendation for Specialty Toys concerning the product Weather Teddy is as follows (supported in Appendix Chart #5): * The company should order 21,000 units of Weather Teddy for the upcoming holiday season. With this order, we would realize the profit potential from a best case scenario, in which we would have to order more than 20,000 units. We do not want to have regret concerning our maximum profit potential and order too few units if the demand exceeds the most likely scenario. We would only incur a loss of $41,000 if the worst case scenario is realized. This is much more favorable than ordering either of the two larger management recommendations, which would incur much greater losses because of the quantity of inventory left-over. In fact, the demand would only need to be approximately 12,160 to break even with 21,000 units ordered. This is still well below our most likely scenario of 20,000 units. With this recommendation, we do not incur much chance of taking a loss under the worst case scenario but will still realize the profit potential from the best case scenario. Appendix Appendix Continued