The strategy - making optimal use of backup agreements between catalogers and manufacturers - was the subject of a study conducted at the women's fashion department of a multibillion-dollar retail giant, which asked not to be identified. The study presented a mathematical model that optimizes the company's method of using backup agreements.
The possible ramifications are significant for industries whose buyers play the high-stakes game of guessing several seasons ahead what customers will buy.
Dr. Gary D. Eppen of the University of Chicago, one of the study's authors, said, "The concepts are applicable to a wide variety of situations and products: other catalog companies and product lines, retail stores for any product where styles change, and electronic products with a short product life. Our retrospective test showed an increase of almost 50% in net cash. This could translate into millions of dollars with broad application."
Backup agreements state that if a catalog company commits to a number of units for a season, the manufacturer holds back a fifth to a third of the commitment. After observing early demand, the catalog company can order up to this backup quantity for the original purchase cost and receive quick delivery. Catalogers pay a penalty as high as 20% for backup units they don't buy. The company studied already had a limited number of backup agreements, with DKNY, Liz Claiborne, and others.
Using methods employed by operations researchers and management scientists, the authors constructed mathematical models to aid in the decision-making process. They tested their results using as inputs the fashion buyers’ initial estimates for 1993 and actual sales data from 1990 - 1992. They compared the results for 1993 that the model would have obtained to the actual results. This retrospective study found that the company's net cash of $78,000 (based on sales revenue of $646,000) would have climbed to $114,000 (with sales of $656,000), an increase of nearly 50%. Surprisingly, the model is also likely to maintain the manufacturers' profit.
The study, "Backup Agreements in Fashion Buying - The Value of Upstream Flexibility," was written by two operations researchers, Dr. Eppen, the Ralph and Dorothy Keller Distinguished Service Professor of Operations Management at the University of Chicago's Graduate School of Business, and Ananth V. Iyer, Associate Professor of Management at Purdue University's Krannert Graduate School of Management. It appears in the current issue of Management Science, a publication of INFORMS. A companion article by the two authors, "Improved Fashion Buying with Bayesian Updates," will appear in the next issue of another INFORMS publication, Operations Research.
The Institute for Operations Research and the Management Sciences (INFORMS) is an international scientific society with 12,000 members, including Nobel Prize laureates, dedicated to applying scientific methods to help improve decision-making, management, and operations. Members of INFORMS work primarily in business, government, and academia. They are represented in fields as diverse as airlines, health care, law enforcement, the military, the stock market, and telecommunications.