Question

If you were a manufacturer describe how you would go about setting the supply lead time penalty alpha.

Answer 1

Lead time violation will lead to stockouts or backorders if no action is taken at the manufacturer's end. In general, every manufacturer will have their own way of managing the uncertainties in delivery lead time. The manufacturer either have additional safety stock or additional resources (e.g. overtime, excess manhours, space machines, other suppliers ready) in order to avoid the stockouts or the resulting loss of goodwill or market share because the loss of goodwill due to service level failure have a much larger impact compared to retaining additional resources. So, when defining the supply lead time penalty in the contracts, the manufacturer should go through the historical data of the deliveries form the supplier and based on the variances in the delivery lead time for a supplier, estimate the additional cash outflows in terms of resources or inventories. based on this estimates, the value of alpha needs to be set.