exercise W93C18

January 25, 2013

Just Baked Inventory ManagementExercise

Just Baked is an upscale, specialty cupcake bakery headquartered in Livonia, Michigan. Just Baked got
its start in founder Pam Turkins kitchen when she began to make smore cupcakes for her children. Word of
mouth spread the news and she began to supply cupcakes for office events. As she experimented with more
and more flavors of gourmet jumbo cupcakes, she realized there was significant unmet market demand for
premium cupcakes in the Detroit area. Just Baked grew from one retail store in 2009 to thirteen stores in
early 2013. Most stores are owned and operated by franchisees, though a few are company-owned.
Demand for cupcakes exhibits patterns based on seasons, store location, day of the week, and time of
day. The freshness promise implicit in the name Just Baked had to be supported by the daily baking
and topping of thousands of cupcakes at the Livonia bakery as well as early-morning delivery of cupcakes
to each store.

Retail Store-Level Cupcake Inventory Planning

Just Baked cupcakes sold at retail stores for prices ranging from about $2.30 each for simpler cupcakes
by the dozen up to about $3.50 for the fanciest cupcakes sold individually. Most of the cupcakes were sold
in 2-packs priced at $5.50. An approximate overall average selling price was $2.75 per cupcake. Franchisees
were charged $1.25 per cupcake. Company-owned stores were also charged the same transfer price of $1.25
per cupcake. Total variable costs per cupcake out of the Livonia bakery were about $0.50, representing $0.25
in direct material and $0.25 in variable labor. Cupcakes not sold by the end of the day were discarded. Just
Baked credited the stores $0.75 for each unsold/discarded cupcake.
Research indicated that customers were generally willing to purchase cupcakes from those available,
even if they had to substitute a second choice for a most-preferred flavor. For the purposes of this exercise,
understocking costs are confined to the immediate lost sales profit.
In practice, Just Baked did not permit franchisees to make their own cupcake-ordering decisions.
Instead, cupcakes were baked and delivered to all stores based on centralized decisions.
Published by WDI Publishing, a division of the William Davidson Institute (WDI) at the University of Michigan.
2013 Eric Svaan. This exercise was developed by Eric Svaan, Lecturer of Technology and Operations at the University of Michigans
Ross School of Business. Acknowledgements go to graduate students Eric Bradshaw, Jeffrey Leinbach, Roopesh Panthalath, and Radhika
Shukla, whose consulting project in 2012 about delivery operations and business growth modeling contributed as the initial basis for
this case. The author disguised some data within this case to protect the companys confidentiality. The author thanks Pam Turkin for
her support in the creation of this exercise.

This document is authorized for use only in Prof Indrajit Mukherjee's Operations Management -II-1 course at Shailesh J. Mehta School of Management, from January 2017 to July 2017.

Just Baked Inventory ManagementExercise

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Raw Material Inventory Planning

When Pam Turkin began the business in her kitchen, she used a particular brand of packaged cake mix
in two flavors (vanilla and chocolate) as the basic material on which all the Just Baked (JB) flavor recipes
were variations. Even though the business had grown dramatically, this recipe structure remained. The cake
mixes were bought in pallet-load quantities for JB. Due to the strong weekly cupcake sales pattern, inventory
planning for cake mix was done on a weekly basis. Cake mix orders were placed with a grocery store chain
distribution warehouse. Cake mixes were delivered 3 days after order placement.
Occasionally, the grocery warehouse had insufficient inventory to fill JBs orders, resulting in insufficient
raw material to support JBs baking operations. When this happened, JB employees would drive to grocery
stores in the Livonia vicinity and buy boxes of cake mix off the store shelves until they had enough to
support the baking operations. This typically required visits to about 20 retail stores, and in Turkins words
it takes all day. Coping with this situation required an average of 15 hours of employee overtime and cost
$20 per hour inclusive of mileage expenses. Prices paid in the stores were also higher, amounting to an extra
cost per pallet of $300.
Although Just Baked had grown via reinvestment of retained earnings, 12% is a reasonable approximation
for the relevant annual cost of capital i which should be considered to apply to inventory holding of cake
mix. Assume 360 days per year. Physical holding costs are negligible at the margin, since the Livonia facility
has sufficient warehouse space to accommodate all reasonable inventory required. Obsolescence and shelf
life considerations also do not apply to cake mixes, which are typically coded for sale up to eighteen months
after packing. The value of a pallet of cake mix at JBs cost including delivery charges is $1000.
Real butter and fresh eggs are also important ingredients in Just Baked cupcakes. These are managed
according to a continuous review system and ordered whenever inventory levels reach a reorder point. Annual
demand D for eggs is 600,000. The cost of placing an egg order S, including delivery charges, is $40. Lead
time for eggs is 1 day. Holding costs for eggs are dominated by their limited shelf life and the requirement
that they be held in cold storage and handled with care. These costs total $0.02 per egg per day. Financial
holding costs are negligible.
Daily demand for eggs averages about 1600, but there are significant variations from day to day. The
standard deviation of daily egg demand is 400. Daily demand for eggs is approximately normally distributed.

Computing Inventory Management Parameter Values

Directions
Please calculate the following values. You may use the Hints at the end of this exercise, and you may
use the Notes pages at the back of this exercise for your calculations.
1. Best Service Level at each Just Baked store.
a. Cost of Understocking Cu. Compute the understocking cost Cu for franchisees and for companyowned stores.
b. Cost of Overstocking Co. Compute the overstocking cost Co for franchisees and for companyowned stores.
c. Franchisee Best Service Level Computation. Compute the Best Service Level SL* for cupcake
stocking at franchisee stores.
2

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Just Baked Inventory ManagementExercise

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d. Company-owned store Best Service Level Computation. Compute the Best Service Level
SL* for cupcake stocking at company-owned stores.
e. Based on your answers to parts 1c and 1d, why does centralized decision-making for storelevel inventory lead to higher overall profitability for the entire Just Baked supply chain than
the alternative model of allowing franchisees to do their own ordering?
Answers
a. _____________________________________________________________________
b. _____________________________________________________________________
c. _____________________________________________________________________
d. _____________________________________________________________________
e. _____________________________________________________________________
_____________________________________________________________________
2. Exposure Period, Cake Mix for Baking.
a. Review Period. Compute the Review Period for cake mix in days.
b. Lead Time. Compute Lead Time for cake mix in days.
c. Exposure Period. Compute the Exposure Period for cake mix inventory planning.
Answers
a. _____________________________________________________________________
b. _____________________________________________________________________
c. _____________________________________________________________________
3. Stockout and Holding Costs, Cake Mix for Baking.
a. Stockout Costs. Compute the cost of a Stockout of cake mix.
b. Holding Costs. Compute the annual Holding Cost of a pallet of cake mix.
c. Cost of Overstocking through 1 Review Period. Compute the weekly holding cost per pallet
of cake mix.
d. Best Service Level for Cake Mix. Compute the Best Service Level SL* for pallets of cake mix.
Answers
a. _____________________________________________________________________
b. _____________________________________________________________________
c. _____________________________________________________________________
d. _____________________________________________________________________

This document is authorized for use only in Prof Indrajit Mukherjee's Operations Management -II-1 course at Shailesh J. Mehta School of Management, from January 2017 to July 2017.

Just Baked Inventory ManagementExercise

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4. Target Stock and Ordering Decisions, Cake Mix for Baking.

We can treat the occasional unavailability of cake mix pallets from the grocery store warehouse
as an unexpected demand for extra cake mix material. With this treatment, demand for pallets of
vanilla cake mix in the 10-day Exposure Period is distributed as shown in the table below, in the
two left-hand columns. This data is used to fill in the center column, Cumulative Probability.
a. Target Stock Level Computation. Compute the Target Stock Level for vanilla cake mix, using
information from the table below.
Pallets of
Cake Mix
Demanded

Probability

Cumulative
Probability

Cumulative
SL*?
Target Stock Level ID (OUTL)*

Fewer than 2

.10

.10

.30

.40

.55

.95

.04

.99

.007

.997

.003

1.00

Sum:

1.00

* Order Up To Level

b. Order Quantity Computation. Suppose that on next weeks review day, JB finds 2 pallets of
vanilla cake mix on hand. How many pallets should JB order?
Answers
a. _____________________________________________________________________
b. _____________________________________________________________________
5. Ordering Eggs.
a. Economic Order Quantity Computation. Compute the Economic Order Quantity Q* for eggs.
b. Safety Stock Computation. Compute the safety stock of eggs it would take to assure a
99.87% service level.
c. Reorder Point Computation. Compute the Reorder Point for eggs, using the safety stock that
you calculated in 5b.
d. Days of Supply expression of ROP. We could express the Reorder Point rule from part 5c this
way: Order more eggs when the supply is X days. Give an expression for X.
e. Average Eggs on Hand. Compute the average daily quantity of eggs on hand, using your
answers to parts 5a and 5b. Express also in Days of Supply.
f. *Days of Supply CV (challenge question). Suppose that Just Baked reduced its required
service level for eggs from the 3-sigma level of 99.87% to the 2-sigma level of 97.7%.
Express the average on-hand Days of Supply of eggs in terms of the coefficient of variation of
daily demand for eggs CV = /.

This document is authorized for use only in Prof Indrajit Mukherjee's Operations Management -II-1 course at Shailesh J. Mehta School of Management, from January 2017 to July 2017.

Just Baked Inventory ManagementExercise

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Answers
a. _____________________________________________________________________
b. _____________________________________________________________________
c. _____________________________________________________________________
d. _____________________________________________________________________
e. _____________________________________________________________________
f. _____________________________________________________________________

Hints
1. Best Service Level at each Just Baked store. (Newsvendor Model application)
a. Cost of Understocking Cu. Hint: For the franchisees, running out of cupcakes before the
end of the day imposes an immediate opportunity cost of lost sales equal to the difference
between their cost of $1.25 and the selling price of $2.75. For company-owned stores, the
understocking cost Cu is equal to the difference between their variable cost of $0.50 and the
selling price of $2.75.
b. Cost of Overstocking Co. Hint: For the franchisees, cupcakes left over at the end of the day
cost them the difference between the price they pay and the credit from JB corporate. For
company-owned stores, cupcakes left over cost them only the JB variable cost.
c. Franchisee Best Service Level Computation. Hint : SL* = Cu / (Cu + Co)
d. Company-owned store Best Service Level Computation.
Hint : SL* = Cu / (Cu + Co)
e. Central Ordering Decisions. Hint: Compare answers to c and d above.
2. Exposure Period, Cake Mix for Baking. (Periodic Review: Exposure Period)
a. Review Period. Hint: Weekly planning
b. Lead Time. Hint: LT = time between order placement and order receipt.
c. Exposure Period. Hint: Exposure Period = Review Period + Lead Time.
3. Stockout and Holding Costs, Cake Mix for Baking. (Newsvendor parameters)
a. Stockout Costs. Hint: Stockout Cost = extra labor + extra cake mix cost.
b. Holding Costs. Hint: Annual Holding Cost H = i C
c. Cost of Overstocking through 1 Review Period. Hint: This is your answer to part 3b divided
by 52.
d. Best Service Level for Cake Mix. Hint: SL* = Cu / (Cu + Co).

This document is authorized for use only in Prof Indrajit Mukherjee's Operations Management -II-1 course at Shailesh J. Mehta School of Management, from January 2017 to July 2017.

Just Baked Inventory ManagementExercise

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4. Target Stock and Ordering Decisions, Cake Mix for Baking. (Periodic Review Q*)
a. Target Stock Level Computation. Hint: Find the first value in the Cumulative Probability
column that is greater than the SL* you computed in part 3d. That number of pallets
represents the best Target Stock Level for vanilla cake mix. This is also known as the Order Up
To Level, OUTL. At each Review Point, Just Baked should count the pallets it has, and then
order the difference between the Target Stock Level and the number of pallets on hand Inet.
b. Order Quantity Computation. Hint: Q* = OUTL on-hand inventory.
5. Ordering Eggs. (Continuous Review: EOQ and ROP computations.)
a. Economic Order Quantity Computation. Hint: Q* =
Second hint: Convert demand and holding costs to daily values.
b. Safety Stock Computation.
Hint: The z-value associated with SL = 99.87 is 3.00. Safety Stock = z
c. Reorder Point Computation.
Hint: ROP = expected demand in Lead Time + Safety Stock.
d. Days of Supply expression of ROP. Hint: answer from 5c / daily demand
e. Average Eggs on Hand. Hint: Iavg = Q/2 + SS. To express in Days of Supply, divide by daily
demand.
f. *Days of Supply CV (challenge question). Hint: SS = zSLEP.

This document is authorized for use only in Prof Indrajit Mukherjee's Operations Management -II-1 course at Shailesh J. Mehta School of Management, from January 2017 to July 2017.

Just Baked Inventory ManagementExercise

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Notes

This document is authorized for use only in Prof Indrajit Mukherjee's Operations Management -II-1 course at Shailesh J. Mehta School of Management, from January 2017 to July 2017.

Established at the University of Michigan in 1992, the William Davidson Institute

(WDI) is an independent, non-profit research and educational organization focused on
providing private-sector solutions in emerging markets. Through a unique structure
that integrates research, field-based collaborations, education/training, publishing,
and University of Michigan student opportunities, WDI creates long-term value for
academic institutions, partner organizations, and donor agencies active in emerging
markets. WDI also provides a forum for academics, policy makers, business leaders, and
development experts to enhance their understanding of these economies. WDI is one
of the few institutions of higher learning in the United States that is fully dedicated to
understanding, testing, and implementing actionable, private-sector business models
addressing the challenges and opportunities in emerging markets.

This document is authorized for use only in Prof Indrajit Mukherjee's Operations Management -II-1 course at Shailesh J. Mehta School of Management, from January 2017 to July 2017.