PROJECT REPORT

LOGISTICS AND SUPPLY CHAIN MANAGEMENT

A CASE STUDY AT CARGO

GROUP - 4

BM 2019-21

Ronit Ray – B19040

Tosha Trivedi – B19056

Ankur Goyal – B19125

Samriddhi Vashishtha – B19162

Suhasini Sharma – B19175

 CONTENTS

Background / Case Synopsis...............................................................................................................2

Cargo and Its Drivers..........................................................................................................................3
Q1. What Strategy do you think the drivers used to decide what orders to place? Comment
on this choice of strategy.................................................................................................................4
Q2. On average, what is the sum of profit made by the drivers and by Cargo over each two –
month replenishment period?.........................................................................................................4
Q3. Suppose we were still using the first strategy (i.e. decentralized decisions), but that the
drivers now correctly optimized the quantity to order in each period. What would be the sum
of the profit made by Cargo and its drivers over each of two-month replenishment period?...5
Q4. Suppose we are now using second strategy (i.e., centralized decisions) so that Cargo
makes decisions for each driver in each period to optimize the total revenue earned by the
drivers. What would be the sum of the profits made by the Cargo and its drivers over each
two-month replenishment period?.................................................................................................6
Q5. Based on your answers above, write a paragraph summarizing the pros and cons of
the centralized and decentralized strategy?...................................................................................6
Q6. Trends in Demand Pattern (Optional Question)....................................................................7
Cargo and Its Suppliers......................................................................................................................8
Q1. We consider and simulate the supply chain under a wholesale price contract. As
mentioned, we use a retail price of $10, a unit production cost of $2.50, and a (monthly)
demand that is normally distributed with mean 1,000 and standard deviation 200. The
demand realizations are given in the spreadsheet.........................................................................8
Q2. The supply chain’s First Best profit is defined as the profit under the ideal solution where
the entire supply chain is owned by one party, i.e., the centralized supply chain.......................9
Q3. Re-solve questions 1 and 2 using a salvage value of $1. How does it affect the results?
Please elaborate..............................................................................................................................10
Q4. We now consider using a revenue sharing contract. We start with a wholesale price w of
$0.75 and a revenue share percentage y of 0.7.............................................................................13
Q6. (Optional) The Buyback Contract:.......................................................................................14

Background / Case Synopsis

Cargo’s mission is to help “rideshare drivers earn more money by providing complimentary
and premium products to passengers”. In addition to items for sale, each Cargo box contains
free sample products provided to Cargo by brand partners interested in connecting to their
customers, testing new products, or generating aggregated data on transactions, such as
time and locations that products are consumed.

As the company started to grow, Cargo faced several supply chain related challenges. In
meeting these challenges, the founder’s priorities were threefold:
1) Simplify operations as much as possible for drivers
2) Models for prediction and replenishment and ordering decisions
3) Ensure their supply chain decisions resulted in a system that was efficient and did not
leave money on table

Cargo needed to optimize the effectiveness of the effectiveness of these new systems to
address the complexities of the firm’s two-sided supply chain.

Cargo and its Drivers: Supply chain Centralization

Cargo and its Suppliers: Revenue Sharing Contracts

Cargo now, using a simulated study wants to evaluate the revenue it could earn using both
kinds of contracts.

Cargo and Its Drivers 

Q1. What Strategy do you think the drivers used to decide what orders to
place? Comment on this choice of strategy.
The drivers have chosen a strategy which maximizes their profit from the deal. Information
asymmetry exists between the drivers and Cargo since the drivers are not aware of the
prices from suppliers. From the data given, the drivers used the actual demand data from
the previous period to forecast and decide the order quantity for the next period.

They would prefer

a) Decentralized strategy where they have the option to have a deferred payment
structure. This would lead to lowering of their burden with respect to blocking of
capital.
b) They would want full freedom to place order based on the demand assessment and
market conditions they perceive on ground

This strategy although might improve the profit for the drivers but it is short-sighted and
does not incorporate scientific approach to maximize profit. The drivers face high risk of
overstocking or understocking in case of fluctuation of demand which can be difficult to
predict without statistical analysis. Also, the overall supply chain profit is not maximized in
this strategy.
Hence, a newsvendor model approach can be an alternative to arrive at an optimal ordering
quantity so as to maximize the total profit of the entire supply chain.

Q2. On average, what is the sum of profit made by the drivers and by Cargo
over each two – month replenishment period? 

From the data provided, we have the actual demand of every period along with the quantity
ordered by the drivers during that period.

Driver Profit:
Πd = Revenue – Cost = Quantity Demanded * (Retail Price – Price to Cargo Driver) - Quantity
Ordered * ( Price to Cargo Driver)

The salvage value is 0 in this case and therefore any overstocking in driver’s end is wasted
at the end of each period. Also, in case of understocking the driver cannot order any more
quantity and therefore the total sales is due to the ordered quantity.

Cargo Profit
Πs = Revenue – Cost = Quantity Ordered * (Price to Driver – Price from Supplier)

Total Profit of the Supply Chain: 

Πsc = Πs + Πd (i.e. Profit of Cargo + Profit of the Drivers)

 
We have calculated the individual profit and the total for every order period and the same is
shown in the attached excel worksheet. The summary is given below:
 Agent  Total Profit  Average Profit 
Driver  $4157.00  $24.74 
Cargo  $32,612.00  $194.11 
Entire Supply Chain  $36,767  $218.85 
 
Q3. Suppose we were still using the first strategy (i.e. decentralized decisions),
but that the drivers now correctly optimized the quantity to order in each
period. What would be the sum of the profit made by Cargo and its drivers
over each of two-month replenishment period?

In order to find out the optimal ordering quantity for given data, we will use the
newsvendor model approach since the demand is not known at the time of ordering and
therefore this model will be the best way to approach this problem.

Using the News Vendor Model for Stochastic Demand: 

Over Stocking Cost (Co): Price to Drivers– Salvage Value (=0)
Under Stocking Cost (Cu): Retail Price – Price to Drivers 
Critical Ratio: F(Q) = Cu / (Cu + Co) 
We will find z value from the standard normal distribution table.

Optimal Order Quantity:  

Q = Mean Demand (µ)+ Standard Deviation of Demand (σ) * z value (Derived from Critical
Ratio) 

Profit of the Cargo: 

Order Quantity * (Price to Cargo Drivers – Price from Suppliers) 

Profit of the Cargo Drivers: 

If Demand > Order Quantity:  Order Quantity * Understocking Cost – (Demand Quantity –
Order Quantity) * Understocking Cost 
Demand <=Order Quantity:  Demand * Understocking Cost – (Order Quantity – Demand) *
Over Stocking Cost 
Total Profit of the Supply Chain: Profit of Cargo + Profit of the Cargo Drivers 
As per the data given and formula used, we have shown the sum of the profits for each of
the ordering period in the attached excel. The summary of the Average and Total Profit for
different supply chain agents are: 

Agent  Total Profit  Average Profit 

Driver  10,849  64.58 
Cargo  26,075.96  155.21 
Total  36,925.93  219.80 
Q4. Suppose we are now using second strategy (i.e., centralized decisions) so
that Cargo makes decisions for each driver in each period to optimize the total
revenue earned by the drivers. What would be the sum of the profits made by
the Cargo and its drivers over each two-month replenishment period?

In the centralized case, there will be a change in the understocking and overstocking cost
and the risk of understocking or overstocking will shift to Cargo from its drivers.
Again, using the newsvendor model for Stochastic Demand for the Entire Supply Chain: 

Over Stocking Cost (Co): Price from the Supplier 

Under Stocking Cost (Cu): Retail Price – Price from the Supplier 
Critical Ratio: F(Q) = Cu / (Cu + Co) 

Optimal Order Quantity:

Q=   Mean Demand (µ) + Standard Deviation of Demand (σ) * z value (Derived from Critical
Ratio) Profit of the Entire Supply Chain:

If Demand > Order Quantity: 

Order Quantity * Understocking Cost – (Demand Quantity – Order Quantity) *
Understocking Cost 
Demand <=Order Quantity: 
Demand * Understocking Cost – (Order Quantity – Demand) * Over Stocking Cost 
As per the data given and formula used, we have calculated the profit of the of Cargo (i.e.
for the entire supply chain) and the same is shown in the excel attached. The summary of
the Average and Total Profit for entire supply chain is shown below:
 
Agent  Total Profit  Average Profit 
Total  38,579.59  229.64 

Q5. Based on your answers above, write a paragraph summarizing the pros and
cons of the centralized and decentralized strategy? 

 Pros of Centralized Strategy:

a) From the results above, we see that in the centralized case the overall profit of the
supply chain is higher as well as the average supply chain profit is also higher
compared to the decentralized strategy

Cons of centralized strategy:

a) From the results above, we see that the drivers do not have any share in the profit of
the Cargo company and therefore they will have no incentive to carry or bear the
inventory provided by Cargo (although free of cost). Hence, the drivers will not be
interested to follow this approach and will not come aboard with the strategy.
 b) The company might lose out the chance to push sales through the drivers since the
driver does not have an additional incentive in this case.

Pros of decentralized strategy

a) Here, we can see that the drivers get a share of the revenue and therefore it can act
as an incentive for them to use this strategy. Having a share will mean that their
interest will be aligned with that of the company i.e. increase the sales of the
products. They can act as salesman apart from being cargo drivers.
b) The drivers will have better knowledge of the actual demand and will actively
provide input to company whether drivers give order for the quantity.
c) In case of news vendor model, we see that the profit of driver is also considerably
significant and therefore drivers will be interested in this strategy.
d) In one of the alternatives where the drivers order and bear the risk of overstocking
and understocking, the company stands to delegate the risk and only take part in the
upside i.e. profit from the sales.

Cons of decentralized strategy

a) The profit is less than that of the centralized case as seen from the results above.
b) The more the fragmented the network is, more the chances of inefficiency creeping
in the supply chain thereby reducing the overall supply chain profit.

Q6. Trends in Demand Pattern (Optional Question)

We segregated the demand basis Year, Month and Time and performed trend Analysis on
demand, the results of which are as follows:
Day of the Week: The demand shows a constant increase during the week as can be shown
from the trend analysis below.

Demand
2158 2292
2500 1878 2063 2054
1835 1843
2000
DEMAND

1500
1000
500
0
0 1 2 3 4 5 6 7 8
WEEK DAY

Month: The Aggregate Demand showed slump after the month of January and picked up at
the later months of the year during December. One probable reason could be higher
tendency to spend by customers during holidays like Christmas, New Year and Easter.
 Demand
1500
DEMAND

1000
500
0
0 2 4 6 8 10 12 14
MONTH

Year: The Demand was increasing during the year,but saw a sudden slump during 2019 as
can be shown from the graph below.

Demand
8000
7000
6000
5000
DemAND

4000
3000
2000
1000
0
2017 2018 2019
Year

 Cargo and Its Suppliers 

Q1. We consider and simulate the supply chain under a wholesale price
contract. As mentioned, we use a retail price of $10, a unit production cost
of $2.50, and a (monthly) demand that is normally distributed with mean 1,000
and standard deviation 200. The demand realizations are given in the
spreadsheet. 

a. Under the wholesale price of $5, what is the retailer’s optimal order quantity? 

Production cost $ 2.50

Retail price $ 10.00
Wholesale price $ 5.00
Retailer’s optimal order quantity 1000

The retailer’s optimal quantity has been calculated for a production cost of $2.50, Retail
price of $10.00 and Wholesale Price of $5.00.
 b. Under the wholesale price of $5, compute the expected profit of a retailer and of
the supplier. 
 
Average Retailer Profit $ 4,245.30
Supplier Profit $ 2,500.00
Total supply chain profit $ 20,23,590.00
Average Supply Chain Profit $ 6,745.30

c. Vary the value of the wholesale price between $2.50 and $10 and find the value
that yields the highest possible profit for the supplier. What is this wholesale price
value? 

Production cost $ 2.50

Retail price $ 10.00
Wholesale price $ 9.00
Retailer’s optimal order quantity 1000

This wholesale price indicates the value for which the supplier’s profit is maximised.

d. For the wholesale price value obtained in Part 1c, what is the total expected profit
of the supply chain (i.e the sum of the retailer’s profit and the supplier’s profit)? 
  
Average Retailer Profit $ 245.30
Supplier Profit $ 6,500.00
Total supply chain profit $ 20,23,590.00
Average Supply Chain Profit $ 6,745.30

 
Q2. The supply chain’s First Best profit is defined as the profit under the ideal
solution where the entire supply chain is owned by one party, i.e., the
centralized supply chain

a. What is the supply chain’s optimal order quantity?

Production cost $ 2.50

Retail price $ 10.00
Wholesale price $ 5.00
Supplier’s optimal order quantity 1134.89795

The supplier’s optimal quantity has been calculated for a production cost of $2.50,
Retail price of $10.00 and Wholesale Price of $5.00.
 b. What is the First-Best expected profit?

Average supply chain profit $ 6963.82

$
Total Supply Chain Profit 20,89,145.71

c. How does the retailer’s order quantity (from Part 1a) compare to the First
Best’s optimal order quantity (from Part 2a)? Why is it the case? Carefully justify your
answer.

Part 1a
Retailer’s order quantity 1000
Part 2a
First Best’s optimal order quantity 1134.89795

The First Best’s order quantity is higher than that of Retailer’s order quantity because First
Best is centralised in nature because the critical ratio in case of First best is higher than the
critical ratio in case of Retailer’s order quantity. This is because the decrease in the
overstocking cost and increase in the understocking cost. There is also a phenomenon of
double marginalization taking place in the decentralized strategy which is leading to lower
optimal order quantity.

d. How does the total expected profit (from Part 1d) compare to the First-Best
expected profit (from Part 2b)? Why is it the case? What is the relative difference between
these two values?
 
Part 1d
Total expected profit $ 20,23,590.00
Part 2b
First Best’s expected profit $ 20,89,145.71

The total expected profit in case of First Best is higher than the Total expected profit (from
Part 1d) because the optimal order quantity has increased in case of First Best because of
higher critical ratio in case of First best.

Q3. Re-solve questions 1 and 2 using a salvage value of $1. How does it affect
the results? Please elaborate.

a. Under the wholesale price of $5, what is the retailer’s optimal order quantity? 

Production cost $ 2.50

Retail price $ 10.00
Wholesale price $ 5.00
 Retailer’s optimal order
quantity 1028

Here, critical ratio comes out to be 0.55, leading to z=0.14.

Since optimal order quantity (Q) = U + (Sigma*z) = 1028

However, with salvage value = $0, the optimal order quantity is 1000 as can be seen in
question 1 of part 2. This shows that if the salvage value increases, this leads to an
increase in the optimal order quantity due to marginal reduction in the risk associated
to overstocking.

b. Under the wholesale price of $5, compute the expected profit of a retailer and of the
supplier

Average Retailer Profit $ 4,245.21

Supplier Profit $ 2,569.86
Total supply chain profit $ 20,44,519.44
Average Supply Chain Profit $ 6,815.06

With as little as $1 increment in salvage value, increase in profits as following can be

seen which is relatively substantial. Following is the increase in corresponding profits

Average Retailer Profit $ -0.1

Supplier Profit $ 69.86
Total supply chain profit $ 20,929.4
This Average Supply Chain Profit $ 69.8 increase in
profits can be associated with an increase in the optimal order quantity as well as the
reduction in the risks associated with the overstocking due to better salvage value of
the unsold units.

c. Vary the value of the wholesale price between $2.50 and $10 and find the value that
yields the highest possible profit for the supplier. What is this wholesale price value? 

Production cost $ 2.50

Retail price $ 10.00
Wholesale price $ 8.99
Retailer’s optimal order 1058
quantity

This wholesale price indicates the value for which the supplier’s profit is maximised.
This price has been reduced from 9 to 8.99 due to an increase in the salvage value. This
indicates that the reduction in the wholesale price can be compensated by the marginal
increase in salvage value.
d. For the wholesale price value obtained in Part 1c, what is the total expected profit of
the supply chain (i.e the sum of the retailer’s profit and the supplier’s profit)? 
  
Average Retailer Profit $ 661.71
Supplier Profit $ 4913.20
Total supply chain profit $ 1672473.23
Average Supply Chain Profit $ 5574.91

The change in profit is as follows:

Average Retailer Profit $ 416.4

Supplier Profit $ -1586.8
Total supply chain profit $ -351116.8
Average Supply Chain Profit $ -1170.4

This decrease in profit is due to reduction in the wholesale price.

II)

The supply chain’s First Best profit is defined as the profit under the ideal solution
where the entire supply chain is owned by one party, i.e., the centralized supply chain

a. What is the supply chain’s optimal order quantity?

Production cost $ 2.50

Retail price $ 10.00
Wholesale price $ 5.00
Supplier’s optimal order quantity 1136

The supplier’s optimal quantity has been calculated for a production cost of $2.50,
Retail price of $10.00 and Wholesale Price of $5.00.

b. What is the First-Best expected profit?

Average supply chain profit $ 6963.82

$
Total Supply Chain Profit 20,89,145.71

No impact of the salvage value can be seen here in the case of centralization

c. How does the retailer’s order quantity (from Part 1a) compare to the First Best’s
optimal order quantity (from Part 2a)? Why is it the case? Carefully justify your
answer.

Part 1a
Retailer’s order quantity 1000
 Part 2a
First Best’s optimal order quantity 1134.89795

The First Best’s order quantity is higher than that of Retailer’s order quantity because
First Best is centralised in nature because the critical ratio in case of First best is higher
than the critical ratio in case of Retailer’s order quantity. This is because the decrease in
the overstocking cost and increase in the understocking cost. There is also a
phenomenon of double marginalization taking place in the decentralized strategy which
is leading to lower optimal order quantity.

d. How does the total expected profit (from Part 1d) compare to the First-Best expected
profit (from Part 2b)? Why is it the case? What is the relative difference between
these two values?
 
Part 1d
$
Total expected profit 20,23,590.00
Part 2b
$
First Best’s expected profit 20,89,145.71

 The total expected profit in case of First Best is higher than the Total expected profit
(from Part 1d) because the optimal order quantity has increased in case of First Best
because of higher critical ratio in case of First best.

Q4. We now consider using a revenue sharing contract. We start with a wholesale price
w of $0.75 and a revenue share percentage y of 0.7.

e. What is the retailer’s optimal order quantity? What can you say on this
value?

The optimal order quantity is 1136 in the revenue sharing contract with the wholesale
price of $0.75 and revenue percentage y of 0.7

b. Compute the retailer’s expected profit and the supplier’s expected profit under the
above revenue sharing contract. What can you conclude?

The retailer and the supplier expected profits are as follows:

Average Retailer
Profit $ 2,089.15
Supplier Profit $ 4,874.67
 This shows that the profits are substantially more than the wholesaler model for both
the retailer as well as the supplier. Making this model a more mutually beneficial model
for both parties.

c. When comparing the wholesale price contract to the revenue sharing contract,
who benefits? Justify your answer.

On comparing the two contracts, we see that the profits of the retailer as well as the
supplier are more for the revenue sharing contract. However, the overstocking and
understocking costs are much more for the revenue sharing contract as compared to
the wholesaler contract.
 
Q6. (Optional) The Buyback Contract:

The Buy – Back Price and other parameters obtained are as follows:

Buyback Price 3.331287098

$
Overstocking Cost 1.67
$
Understocking Cost 5.00
Critical Ratio 0.749769869

Because of the Buyback Contract, the overall supply chain profit is better than the
Wholesale Case and is equivalent case.

$
Average Retailer Profit 4,642.18
$
Supplier Profit 2,321.57

$
Total supply chain profit 20,89,125.44
Average Supply Chain $
Profit 6,963.75

As can be seen from the table, the Total Supply Chain Profit is unchanged. However,
compared to the retailer’s profit saw a significant jump as compared to the Wholesale Case.