Scrap or Sell: The Decision on Production Yield Loss

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Author Information : Rong Li (Martin J. Whitman School of Management, Syracuse University)
Yu Xia (Raymond A. Mason School of Business, College of William & Mary)
Xiaohang Yue (Lubar School of Business, University of Wisconsin Milwaukee)

Year of Publication : Productions and Operations Management (2018)

Summary of Findings : Selling production yield loss to value-conscious markets seems to turn scrapping costs into sales profits, but may hurt the manufacturers as they overproduce and sacrifice their primary markets.

Research Questions : What's the best strategy to deal with production yield loss, scrap or sell? What factors does the strategy depend on?

What we know : When the production yield rate is high (say 90%), as observed in most industries, the best strategy is always to scrap all the yield loss and focus on the primary market. This is because when choose to sell the yield loss, manufacturers will overproduce and thus oversupply to their primary market. Rather than earning sub-optimal profit from both value-conscious and primary markets, manufacturers are better off earning optimal profit only from their primary market. The best strategy to deal with production yield loss depends on the yield rate, scrapping cost, market sizes, and price difference of the two markets.

Novel Findings : The semiconductor and other industries, manufacturers are thrilled by turning scrapping costs into sales profits for production yield loss. We find that this may cause manufacturers to overproduce and thus sacrifice their primary markets, especially when their production yield rate is high. Our findings suggest the manufacturers to examine their market and operations parameters to reconsider whether they should switch back to the scrapping strategy.

Implications for Practice : Companies can use this model to determine whether to scrap or sell, optimizing their profits and preserving primary markets.

Full Citations : Li, R., Y. Xia, X. Yue. Scrap or Sell: The Decision on Production Yield Loss. 2018. Forthcoming in Productions and Operations Management.

Abstract : Many production processes not only produce desired quality products (high-end products), but also generate yield loss or Not-Quite-Perfect Products (NQPPs) that do not fully meet the quality standards. In practice, a manufacturer may choose to (1) scrap all NQPPs at a cost and carry the high-end products only, or (2) sell some or all NQPPs to a value-conscious low-end market and carry both high-end products and low-end products (NQPPs). This research studies the optimal decision on production yield loss (scrap or sell) and the corresponding pricing and operational strategies under different practical situations. Building upon a standard marketing model for two separated markets, i.e., the high-end and the low-end markets, we model the manufacturer's profit maximization problem as a nonlinear programming problem. We characterize the optimal yield-loss decision and the corresponding optimal pricing for each market and production quantity. We also consider the situation that the NQPPs may face competition in the low-end market with products designed and produced specifically for that market. In contrast to the common belief that selling NQPPs to a low-end market can recover some of the cost and hence lead to a higher profit, we show that when the yield rate is small or large enough, selling NQPPs may hurt the manufacturer due to the loss of full control over both markets. This is especially true when competition exists in the low-end market. This research provides practitioners with detailed guidelines on when and how a specific yield loss (product line or marketing) strategy should be adopted. Managerial insights are generated for the optimal yield loss strategies; numerical tests further demonstrate our results.

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Selling production yield loss to value-conscious markets seems to turn scrapping costs into sales profits, but may hurt the manufacturers as they overproduce and sacrifice their primary markets.

Rong Li

Assistant Professor of Supply Chain Management at Martin J. Whitman School of Management
Rong Li is an assistant professor of supply chain management whose research interests include operations and finance interfaces, supply chain coordination and contracting, inventory management and maintenance with learning from real-time information. Dr. Li received a B.S. in mathematics from Nankai University, and M.S. and Ph.D. in industrial engineering from Purdue University.
Rong Li
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