Firms have to increase product variety in order to be profitable in the market. Increased product variety makes predicting demand extremely difficult. This is because forecast errors are much greater at individual product level than at aggregate level and as product variety increases, the likelihood of correlation among product forecasts increases. This correlation makes forecasting demand more difficult. The high product variety creates higher demand uncertainty, which in turn requires higher levels of inventory.
Swaminathan(2001) explains the complications in planning and organization created by increased product variety as follows: Deciding how much inventory to carry to guarantee the required service level is more difficult. Predicting equipment capacity requirements is more difficult. Forecasting component requirements is more difficult as well. The increase in the number of components or subassemblies may increase in the number of suppliers, making more costly to manage and changing mechanism more complex. Shorter product life cycles are entailed as well.
The challenge for firms implementing high product variety is to minimize the variability in the operating and distribution processes which is created by product variety. Here, we come across to a critical element that has been overlooked in most product designs. Most of the product design considerations include manufacturability, cost and quality. By changes in product design, it is possible to overcome some of the difficulties created by product variety.
In order to achieve this, in design process it is required to take into account “the relationship between design and eventual customization, distribution and delivery of the product to multiple market segments.” (Lee, et. al., 1993) Standardization of processes or parts gives us a solution.
Swaminathan(2001) describes four standardization approaches:
1.
Part standardization is maximizing component commonality across products.
2.
Process standardization is delaying customization as late as possible.
3.
Product Standardization is carrying a limited number of products in the inventory and providing the customer with a one of the available models that has a superset of features required by the customer.
4.
Procurement Standardization is leveraging equipment and part commonality across parts.
Lee (1997) describes point of differentiation as follows: “At some point in the process, specialized components or processes are then used to customize work-in-process (which was a generic product up to that point in the process) into different end-products. Such a point is usually known as the point of differentiation.” In the following figure, k is the point of differentiation and the aim of delayed product differentiation is to make k as large as possible.
1 2 k
Common operations

According to Garg et al. delayed product differentiation benefits the manufacturers in two ways: it increases their flexibility by enabling them to commit their WIP to a particular endproduct at a later time, and it decreases their costs of complexity by reducing the variety of components and processes within the system. Moreover, Lee (1997) includes the improvement of service level of the system (due to risk pooling) to the mentioned benefits.
Due to its benefits, delayed product differentiation is commonly suggested by supply chain researchers.
Another proposed methodology for improvements is supply contracts. It is known that, total supply chain profits are maximized when all decisions are made by a single decision maker who has access to all available information. However, generally, neither the manufacturer, nor the retailer has the control of the whole supply chain. In order to share the risk of backordering, loss sales or excess supplies and for a system wide improvement supply contracts are suggested. Tsay et al (1999) review the supply contracts literature and classify the supply contracts as follows: 1. Specification of decision rights 2.Pricing 3. Minimum purchase commitments 4. Quantity flexibility 5. Buyback or returns policies 6. Allocation rules 7. Lead time 8. Quality
In this paper, I am going to try to propose a model which incorporates the benefits of delayed product differentiation into supply contracts. The model mainly consists of one manufacturer, which creates products without customization, and retailers which are equipped with customization knowledge. Any one of the mentioned supply contracts can be used in the model. However, for the sake of simplicity, I am going to examine the buyback or returns policies with delayed product differentiation.
The concept of delayed product differentiation was first introduced in the marketing literature by Alderson (1950). The delayed product differentiation concept has been used extensively in the logistics and distribution side of business. Shapiro and Heskett (1985), Zinn and Bowersox
(1988), Zinn (1990), van Doremalen and Fleuren(1991) gave various examples on delayed product differentiation. These papers include examples, simulation models and examinations of specific issues in delayed product differentiation. As an example, in their paper “Planning
Physical Distribution with the Principle of Postponement”, Zinn and Bowersox introduce five levels of postponement strategies, classify them in cost categories and examine their impact on costs. The following table is taken from this paper. It is worth to note that, all kinds of postponements result in decrease in inventory carrying costs, while all result an increase in processing costs.
Normative Cost
Models
Labeling
Packaging
Assembly
Manufacturing
Cost Categories
Inventory carrying costs
Processing (Labeling)
Transportation
Inventory carrying costs
Processing (Packing)
Transportation
Inventory carrying costs
Processing (Assembly)
Cost of Lost Sales
Transportation
Inventory carrying costs
Cost Impact if
Postponement
DOWN
UP
DOWN
DOWN
UP
DOWN
DOWN
UP
UP
DOWN
DOWN

Time
Processing (Manufacturing)
Cost of Lost Sales
Transportation
Inventory carrying costs
Cost of Lost Sales
UP
UP
UP
DOWN
UP
In operational research literature Lee et al.’s paper in 1993 is important as it exemplified delayed product differentiation by means of deferring the localization process for the deskjet printer at Hewlett-Packard. In this paper authors examine the effect of design for localization concept which takes into account the operational and delivery service considerations for the multiple market segments, North American, European and Far East Distribution Centers. In the example, inventories are kept in finished goods form. With factory localization, the deskjet printers were localized (manuals, powers supplies) in the factory and because of long lead time, the DCs had limited ability to respond to fluctuations in the demand for different versions of the product. With DC localization –a generic product is customized at DCs and shipped to the DC’s, localization materials are held in DC’s and localization is performed here.
As a result of this improvement, a reduction of 18% in total inventory investment was achieved.
In his paper in 1994, Lee showed that inventory savings are greater when the demands for different products are negatively correlated. In 1996, he described a model for capturing inventory reduction in an adaptation of multi echelon system. The model assumes no buffer stocks, the inventory reduction comes from finished goods inventory. He concludes that process and product changes are powerful tools in gaining control of inventory and service in the competitive market.
Afterwards, Lee and Tang (1997) developed a model which complements Lee’s (1996) model in the following ways: holding inventories at different points is allowed; not only decrease in the finished goods inventory but also other factors (i.e. design cost, processing cost, inventory cost, lead times) are also examined and specific approaches such as standardization, modular design and process restructuring are examined. As a result of this examination following table is created.
Basic Approach
Redesign Process for Delaying
Product Differentiation
Conditions for Effectiveness
Standardization
Design a part that is common to all products.
Effective when the investment cost and incremental processing cost required for the standardization are low.
Modular Design
Divide a part into 2 modules-the first module is a common part and
The number of modules increases. However, this approach is effective when the incremental lead time, incremental the assembly operation of the processing cost and unit inventory holding cost are low. second module is deferred.
Process Restructuring:
Divide an operation into 2 steps- the first step is common to all
Postponement of products and the execution of the
Operation second step is postponed
Effective when the lead time of the common step is significantly longer than the second step that is being delayed. In addition, this approach is effective when the second step is a high value added activity
Process Restructuring:
Reverse the order of 2 operations.
Effective when deferring the high value-added operation by
Reversal of Operations
As a result, the first operation is common to all products. reversing the operations

In 1997, Garg and Tang were first to examine delayed product differentiation with multiple points of differentiation. The products differentiate from each other at different points, as seen in the figure. The authors model this case with two types of control policies: centralized and decentralized. Early postponement is
Product
Differentiation
Point defined as postponement in family differentiation point whereas late postponement is the other one. They conclude that: In centralized control model, both early
T
1
T
2
T
3 and late postponements results in inventory savings and early postponement is preferred when the demand
Family
Differentiation
Point correlation is high. In decentralized control model, lead times determine the decision of early or late postponement. If T
2
<T
1
, early postponement, if
T
3
<T
2
late postponement is beneficial.
There is still ongoing research on delayed product differentiation concept. Aviv and
Federgruen (2001) examine the design for postponement concept under unknown demand distributions. Yan et. al. (2002) examine the effect of sequencing and merging operations on the reduction of safety stocks. In 2001, in article “The Rediscovery of Postponement a
Literature Review and Directions For Research” Hoek, R.I. van, makes an excellent literature review on postponement strategies. The classification of publications is given in Appendix.
The proposed model incorporates the benefits of delayed product differentiation into supply contracts. As mentioned before, the model mainly consists of one manufacturer, which creates products without customization, and N identical retailers which are equipped with customization knowledge. The product is shipped to the retailers without customization. The retailer performs the customization step.
Generic
Products
The comparison of delayed product differentiation will be performed by comparing this model to a similar one, in which goods are shipped to retailers in customized forms. An (s,S) policy is proven to be effective in the literature and will be
Manufacturer
Retailers
The concept of supply contracts will be examined after the examination of centralized and decentralized control inventory models. It is known that centralized control of supply chain brings higher profits and careful design of supply contracts can realize the same exact profit as the profit in global optimization achieved through centralized control.
Throughout the analysis, the figures will be drawn for one retailer, since the retailers are identical. Moreover, only inventory control analysis is going to be performed for the cases. In fact, a detailed study should include, all cost components like, cost of implementation of a customization mechanism to the retailers, cost of possible additional components for customization, etc.
Centralized Control Analysis
Without vs. With Delayed Product Differentiation

M R
(
 i
,
 i
) c p i
For each retailer the demand for item i is assumed to be Normal with (
 i customized in the manufacturer, each retailer gives an order for N(
 i there are n items, the safety stock is assumed to be equal to (z*
 i
,
 i
,
 i
). When goods are
) for each item i. If
*

L) for each item i, where L is identical lead time and z is safety factor. For a total of n items, the safety stock will be
(n*z*
 i
*

L) at the retailers.
Since the goods are customized in the retailer, they are identical during the ordering process from the manufacturer. In this case, the retailers will place orders on the average n
 the safety stock will be
 n*z*
 i i items and
*

L which is smaller than the first case. In fact, this case’s benefits are exactly the same with risk pooling concept. By shipping generic products, we aggregate customer demand on all products. This implies to a more accurate forecast- from aggregate forecasts are more accurate principle- and smaller variability, as we have seen a reduced safety stock. A note, not examined but worth to add here is that: the benefit from risk pooling decreases as the correlation between the demands of the items becomes more positive.
Decentralized Control Analysis
Without vs. With Delayed Product Differentiation
M R
(
 i
,
 i
) c t p i
When there is a decentralized control, both the manufacturer and the retailer will try to optimize their benefits, separately. The wholesale price t or t i
will be there, in addition to cost and price components in centralized control case. It is known that with decentralized control, only the local optimization can be achieved. When the customization is performed in the factory, the wholesale price will be t i for each item i. The optimum order quantity for each item will be Q i
*
=
 i
+F
-1
{(p i
-t i
)/ p i
}*
 i if no correlation is assumed- Q
*
= n
 i
. And for each retailer the total order quantity will be –
+n*F
-1
{(p i
-t i
)/ p i
}*
 i
.
When the product differentiation is delayed, the wholesale price will be t for generic products.
The optimum order quantity for each retailer will be
Q
*
= n
 i
+
 n*F
-1
{[Avg(p i
)-t]/ Avg(p i
)}*
 i
. Since the average inventory on hand is in proportion to optimal order quantity, we see that risk pooling concept is still at work when decentralized control is used. However, as we already know the global optimization is not achieved and total profit is lower than the one with centralized case.
Supply Contracts Analysis: Buyback Case
Without vs. With Delayed Product Differentiation
M t
R
(
 i
,
 i
) c b p i
A buyback contract establishes who bears responsibility for unsold inventory and to what extent. The main idea is that manufacturer takes some or all of the unsold goods back at the end of the period. There are three types of return policies: 1. Unlimited returns at full credit 2.
Limited returns at full credit 3. Unlimited returns at partial credit. Pasternack (1985), shows that policies that allows for unlimited returns at full credit or no returns are not inefficient and

global optimization benefits can be established using a policy that allows unlimited returns at partial credit, which means in the model b<p.
When goods are customized in the manufacturer, the wholesale price is t i
and the buyback price is b i
for each item. With correct selection of b i
the optimal order quantity and in centralized control case can be achieved. However, the best achieved will be the centralized case without delayed product differentiation.
When delayed product differentiation is achieved and goods are customized in the retailer, the retailer will return the goods without customization with a buyback price b. The best achieved by careful selection of b will be centralized control case with delayed product differentiation.
Moreover, there will be additional benefits of the return policies, since the returned goods are not customized, they can be shipped to another retailer or customized at the manufacturer. It is a kind of risk pooling in the reverse logistics.
We have seen that delaying product differentiation creates great benefits in supply chain management decisions. Most of the researchers have researched the delayed product differentiation in centralized control case, in which one decision maker optimizes the whole system. Some papers also mention the decentralized case, but I couldn’t come across to as detailed examinations as the first case. This may be because delaying the customization and leaving to another supply chain partner might be dangerous. It usually requires high technology transfer and trust between partners. I think there is a kind of similarity between delayed product differentiation to another partner and the outsourcing concept. Delaying product differentiation might be very risky if the manufacturer is dependent on knowledge and the product is an integral product. That’s why; the decentralized control delayed product differentiation should only be used when the customization step is easy to perform. Moreover, since in the model the customization is performed in the retailers, the cost of implementing customization mechanism should be small.
If the decentralized control and delayed product differentiation can be implemented together, the global optimization benefits will not be achieved. So, it is required to have some kind of agreements to optimize profits. Supply contracts issue comes here; we know that careful consideration of supply contracts will lead us to global optimization. In the study, buyback contracts are considered. The study mentioned is mainly a comparison study which aims to show benefits of delayed product differentiation when it is used with supply contracts.

From Hoek(2001),

W. Alderson, “Marketing Efficiency and Principle of Postponement”,
Cost and Profit Outlook ,
September 1950, 3
Y. Aviv and A. Federgruen, “Design for postponement: a comprehensive characterization of its benefits under unknown demand distributions”, Operations Research , 49, 578-598 (2001)
A. Garg and Tang CS, “On postponement strategies for product families with multiple points of differentiation”, IIE Transactions 29 (8): 641-650 (1997)
R.I. van Hoek, “The rediscovery of postponement a literature review and directions for research.”
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H. L. Lee “Design for Supply Chain Management: Methods and Examples ”, Perspectives in
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H. L. Lee AND c. Billington “Designing Products and Processes for Postponement
”,
Management of Design: Engineerig and management Perspectives , 105-122 (1994).
H. L. Lee “Effective Inventory and Service Management through Product and Process
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B. A. Pasternack, “Optimal pricing and return policies for perishable commodities”,
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Van Doremalen, J. and H. Fleuren, “ A Quantative Model for Analysis of Distribution
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