A Potential Hybrid Strategy
The local supplier has also offered another proposal that would allow Teens Forever to use both suppliers, each playing a different role. The Chinese supplier would produce a base quantity for the season and the local supplier would cover any shortfalls that result. The short lead time of the local supplier would ensure that no sales are lost. In other words, if Teens Forever committed to a base load of 900 units with the Chinese supplier in a given period and demand was 900 units or less, nothing would be ordered from the local supplier. If demand, however, was larger than 900 units (say, 1,100), the shortfall of 200 units would be supplied by the local supplier. Under a hybrid strategy, the local supplier would end up supplying only a small fraction of the season’s demand. For this extra flexibility and reduced volumes, however, the local supplier proposes to charge $11/unit if it is used as part of a hybrid strategy.
Questions:
- Draw a decision tree reflecting the uncertainty over the next two periods. Identify each node in terms of demand and exchange rate and the transition probabilities. (8 marks)
- If management at Teens Forever is to pick only one of the two suppliers, which one would you recommend? What is the NPV of the expected profit over the next two periods for each of the two choices? Assume a discount factor of k = 0.1 per period. (6 marks)
- What do you think about the hybrid approach? Is it worth paying the local supplier extra to use it as part of a hybrid strategy? For the hybrid approach, assume that management will order a base load of 900 units from the Chinese supplier for each of the two periods, making up any shortfall in each period at the local supplier. Evaluate the NPV of the expected profits for the hybrid option assuming a discount factor of k
= 0.1 per period. (6 marks)