This chapter shows that the following simple idea can be applied in many ways to manage business risks in the face of uncertainties. The standard deviation of a sum of interdependent random demands can be lower than the sum of the standard deviations of the component demands.
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Notes
- 1.
1Read Chap. 8 to learn more about the Economic Order Quantity model.
- 2.
2That is, z is a normal random variable with mean zero and variance one.
- 3.
3Chapter 7 in this volume presents the basic principles of the newsvendor model.
- 4.
4The payments to X and Y, respectively, are cQ/2 and (c + δ)Q/2, so the sum is (c + δ/2)Q.
- 5.
5In Eq. (38) and the discussion of inventory consolidation, these symbols denote a week's demands at Springfield and Montreal, respectively.
- 6.
6Here, L = 1 in (12) and 13).
- 7.
7Recall the notation z for the fractile of the standard normal distribution where 100α% of the area lies to the right.
- 8.
8Flexibility principles are presented in this volume in Chap. 3.
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Acknowledgments
The author is grateful to Anne, Elizabeth, and Richard for all that they have taught him.
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Sobel, M.J. (2008). Risk Pooling. In: Chhajed, D., Lowe, T.J. (eds) Building Intuition. International Series in Operations Research & Management Science, vol 115. Springer, Boston, MA. https://doi.org/10.1007/978-0-387-73699-0_9
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