Inventory MGMT

Agenda Supply Chain Management: Background Inventory Management Supply Chain Dynamics
Beer Game
Rajesh Piplani, Ph.D. 2006
41
Outline
Inventory Management
Introduction Economic Order Quantity Effect of demand uncertainty
(min, max) policies
Risk pooling
Centralized vs. decentralized systems
Practical issues
Rajesh Piplani, Ph.D. 2006 42
Issues in Inventory control

How much inventory to keep? When to place the next order? What should be the order size?
43
The Challenge of Inventory Management

Matching supply and demand accurately is a challenging task
Cisco had to write down its inventory by $2.5b due to sharp downturn in demand. (2001) Sony could not meet the demand for its newly launched PS2 game console due to shortages of one of the chips. (Christmas, 2000) Dell Computers predicts a loss; stock plunges. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write down. (WSJ, August 1993) IBM continues to struggle with shortages in the Think Pad line. (WSJ, May 1994)
44
Inventory location
Sources: plants vendors ports Regional Warehouses: stocking points
Field Warehouses: stocking points
Customers, demand centers sinks
Supply
Inventory & warehousing costs Production/ purchase costs Transportation costs Transportation costs
Inventory & warehousing costs
Reduce Cost, Improve Service

By effectively managing inventory:
Wal-Mart became the largest retailer by utilizing efficient inventory management (cross-docking, everyday low pricing). GM has reduced parts inventory and transportation costs by 26% annually.
46
Or pay the price.

By not managing inventory successfully
In 2001, Cisco had to write down $2.5b worth of inventory, due to its inability to forecast the sharp downturn in demand. In 2000 (Christmas), Sony could not meet the demand for its newly launched PS2 game console due to shortages of one of the chips. In 1994, IBM could not meet the demand for its ThinkPads, suffering millions of dollars in lost sales. In 1993, Dell Computers suffered a loss because the company was sharply off in its forecast of demand, resulting in huge inventory write downs.
Drivers of Inventory Mgmt.

The inventory policy is affected by:
Demand Characteristics (average, variation) (Replenishment) Lead Time Inventory-related costs (ordering, holding, etc.) Number of Products Objectives
Maximize Service level Minimize costs
48
Inventory Cost Components

Ordering costs
Fixed Variable
Holding Costs
Warehousing costs Insurance Maintenance and Handling Taxes Opportunity Costs (cost of capital) Obsolescence
Stock-out costs
Economies of scale
Why hold Inventory?

Cycle/Batch stock
Fixed costs associated with batches Quantity discounts Trade Promotions
Uncertainty
Information Uncertainty Supply/demand uncertainty
Safety stock Seasonal stock Strategic stock

50
Seasonal Variability Strategic

Flooding, availability
Economies of Scale: Inventory Management for a Retailer

The Bob Little retail shop in the Nanyang Tower has observed a stable monthly demand for its line of Oriental jackets to the order of 100 jackets per month. The retail shop incurs a fixed cost of $2,000 every time it places an order with the Hong Kong warehouse for stock replenishment. The marginal cost of a jacket is $200, and Bob Littles cost of capital is approximately 25%. What order size would you recommend for Bob Little?
warehouse
retailer
Why Holding Costs Increase as Order Quantity per Order Increases

More units must be stored if more ordered
Purchase Order Description Qty. Microwave 1
Order quantity
Order quantity
52
Why Order Costs Decrease as Order Quantity Increases

Cost is spread over more units Example: You need 1000 microwave ovens
1 Order (Postage $ 0.32)
1000 Orders (Postage $320)
Order quantity
Purchase Order Description Microwave Qty. Microwave 1
53
Inventory Trade-off: Cycle stock

Items with high unit price:
Holding cost would be higher compared to fixed replenishment or transportation cost. Therefore would replenish more often resulting in lower inventory. Example: semi-conductors, electronics.
Items with low unit price:

Longer ordering cycle and therefore higher average inventory. Example: Bulk Materials.
EOQ Model: How Much to Order?

Annual Cost
Order (Setup) Cost Curve Optimal Order Quantity (Q*)
Order Quantity
55
EOQ Model
Inventory Level Q
Average Inventory ?
Reorder Point (ROP)
Time
Lead Time
Cycle Inventory Model

Ordering Cost D Inventory Holding Cost Q
TC(Q) = Q K + H 2
D: K: H: Q: Annual Demand Fixed Cost per Order Inventory Holding Cost per Unit per Year Order Quantity per Order
D/Q : No. of Cycles / yr Q/D: Cycle Length (yrs)
Assumption: Constant Demand Rate Whole Lot Delivery No Volume Discount

57
EOQ: Optimal Order Quantity

2DK
H
Q* = EOQ =
2DK
hC
TC(EOQ) = 2 D K H
h = inventory carrying rate per year = holding cost per $ inventory value
Economies of Scale: Bob Little

D = 12*100 jackets/ year h = 0.25 Optimal order quantity = Number of orders per year = D/Q = Time between orders = Q/D = Annual ordering cost = (D/Q)K = Average inventory I = Q/2 = Annual holding cost = (Q/2)H =
C = $ 200 / unit K = $ 2,000 / order
Role of Lead time L: Bob Little Example

The lead time from when Bob Little places an order to when the order is received is one and a half weeks. If demand is stable as before, when should Bob Little place an order? Two key decisions in inventory management are: How much to order? When to order?
60
Learning Objectives: Batching & Economies of Scale

Increasing batch size of production (or purchase) increases average inventories (and thus cycle times). Average inventory for a batch size of Q is Q/2. The optimal batch size trades off setup cost and holding cost. To reduce batch size, one has to reduce setup cost. Square-root relationship between Q and (D, K): If demand increases by a factor of 4, it is optimal to increase batch size by a factor of 2 and produce (order) twice as often. To reduce batch size by a factor of 2, ordering cost has to be reduced by a factor of 4. 61 Rajesh Piplani, Ph.D. 2006
Demand uncertainty and forecasting

Forecasts depend on historical data market intelligence Forecasts are usually (always?) wrong. A good forecast has at least 2 numbers (includes a measure of forecast error, e.g., standard deviation). The forecast horizon must be at least as large as the lead time. The longer the forecast horizon, the less accurate the forecast. Aggregate forecasts tend to be more accurate. (Example: Tomato sauce)
Bob Little warehouses Service levels & inventory management

Bob Little has 4 warehouses which experience a demand that is not steady from one week to the next. Weekly demand (at each warehouse) is in fact Normally distributed with a mean of 5,000 and a standard deviation of 1,500. BLs order lead time is one week. Fixed order costs are $4,000/order and it costs $10 to hold one jacket in inventory for one year.
If BL uses the ordering policy discussed earlier, what will the probability of running out of stock in a given cycle be?
BL would like this probability to be no higher than 5% for customer satisfaction. What ordering policy would you recommend for BL?
(s, Q) policy
Inventory on hand I(t)
Q Q
order order order
ROP R
mean demand during supply lead time:
= R L
I
Is
0
safety stock s
Time t
L
Determining the required Safety Stock: at a Bob Little warehouse

DATA: R = 5,000 jackets/ week H = $ 10 / jacket, year K = $ 4,000 / order
R = 1,500 jackets/ week

L = 1 week
QUESTION: What should safety stock be to ensure a desired cycle service level of 95%? ANSWER: 1. Determine lead time demand 2. Required # of standard deviations z* 3. Answer: Safety stock
= =
Is =
Hedge against demand uncertainty with safety stock

L = Supply lead time, D=N(RR)=Demand per unit time is Normally distributed with mean R and standard deviation R , Cycle service level = P(no stock out) = P(demand during lead time < ROP) = P(N(0,1) < z* = (ROP- )/LTD) = F(z*) [use tables to find z*] Reorder point ROP = RL + Is Safety stock Is = z* LTD = z * R * L
The standard Normal distribution F(z)

Transform X = N() to z = N(0,1) z = (X - ) / . F(z) = Prob( N(0,1) < z)
F(z) 0 z
Transform back, knowing z*: X* = + z*. Rajesh Piplani, Ph.D. 2006 67
Warehouse Inventory Costs for Bob Little

1. Cycle Stock (Economy of Scale) 1.1 Optimal order quantity = 1.2 # of orders/year = 1.3 Annual ordering cost per warehouse = $ 1.4 Annual cycle stock holding cost/w.h. = $ 2. Safety Stock (Uncertainty hedge) 2.1 Safety stock per warehouse = 2.2 Annual safety stock holding cost/w.h. = $ 3. Total Costs for 4 warehouses =4( ) = $.
+
68
Learning Objectives: safety stocks

Is = z * R * L
Safety stock increases (decreases) with an increase (decrease) in

demand variability or forecast error, delivery lead time for the same level of service, service level required.
69
Risk Pooling
Consider two scenarios:
Warehouse One Plant Warehouse Two Market Two Market One
Market One Plant Warehouse Market Two

Risk Pooling
For the same service level, which system will require more inventory? Why? For the same total inventory level, which system will give better service? Why? What are the factors that affect these answers?
71
Risk Pooling
Demand variability is reduced if one aggregates demand across locations.
More likely that high demand from one customer will be offset by low demand from another.
Can reduce safety stock, and therefore average inventory (for the same service level).
72
Centralization at Bob Little

Weekly demand per warehouse = 5,000 jackets/ week with standard deviation = 1,500 / week H = $ 10 / jacket, year K= $ 4,000 / order Supply lead time L = 1 weeks Desired cycle service level F(z*) = 95%. Bob Little decides to merge all four of its warehouses. = =
73
Risk Pooling
Decentralize High Safety Stock Low Service Level
Centralize Low Safety Stock High Service Level

R = 20,000 jackets/week R = Sqrt(4) 1,500 = 3,000 jackets/week 1. Cycle Stock Optimal order quantity Q consolidated warehouse = jackets/order. Annual ordering cost =$ 2. Safety Stock lead time demand Safety stock consolidated warehouse Average inventory consolidated warehouse Average flow time Annual holding cost Total annual cost consolidated warehouse
Warehouse centralization
= 3,000 jackets.
= = = =$ =$ jackets. jackets. weeks.
75
Learning Objectives: Risk Pooling

Centralizing inventory control reduces both safety stock and average inventory level for the same service level. This works best for
High coefficient of variation, which reduces required safety stock. Negatively correlated demand. Why?
76
To Centralize or not to Centralize

What is the effect on:
Safety stock? Service level? Overhead? Lead time? Transportation Costs?
77
Exercise 1
McDonald dairy farm believes that the daily demand for its milk follows a normal distribution with a mean of 100 gallons and a standard deviation of 10 gallons. The cost of ordering from their supplier is $100 and the holding cost per gallon per day is $1.0. If the lead time is a constant 1 day and the desired service level is 95%, find: (a) safety stock, (b) reorder point, (c) average inventory level, and (d) probability of stock-out.
QUESTIONS??
79

Inventory MGMT

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Inventory MGMT

Uploaded by

Copyright:

Available Formats

Agenda Supply Chain Management: Background Inventory Management Supply Chain Dynamics

Rajesh Piplani, Ph.D. 2006

Issues in Inventory control

Rajesh Piplani, Ph.D. 2006

The Challenge of Inventory Management

Field Warehouses: stocking points

Customers, demand centers sinks

Inventory & warehousing costs

Reduce Cost, Improve Service

Rajesh Piplani, Ph.D. 2006

Or pay the price.

Drivers of Inventory Mgmt.

Inventory Cost Components

Why hold Inventory?

Fixed costs associated with batches Quantity discounts Trade Promotions

Safety stock Seasonal stock Strategic stock

Seasonal Variability Strategic

Economies of Scale: Inventory Management for a Retailer

Why Holding Costs Increase as Order Quantity per Order Increases

Purchase Order Description Qty. Microwave 1

Purchase Order Description Qty. Microwave 1000

Why Order Costs Decrease as Order Quantity Increases

1000 Orders (Postage $320)

Purchase Order Description Microwave Qty. Microwave 1

Rajesh Piplani, Ph.D. 2006

Inventory Trade-off: Cycle stock

Items with low unit price:

EOQ Model: How Much to Order?

Order (Setup) Cost Curve Optimal Order Quantity (Q*)

Rajesh Piplani, Ph.D. 2006

Reorder Point (ROP)

Cycle Inventory Model

D/Q : No. of Cycles / yr Q/D: Cycle Length (yrs)

Rajesh Piplani, Ph.D. 2006

Assumption: Constant Demand Rate Whole Lot Delivery No Volume Discount

EOQ: Optimal Order Quantity

Economies of Scale: Bob Little

C = $ 200 / unit K = $ 2,000 / order

Role of Lead time L: Bob Little Example

Rajesh Piplani, Ph.D. 2006

Learning Objectives: Batching & Economies of Scale

Demand uncertainty and forecasting

Bob Little warehouses Service levels & inventory management

Determining the required Safety Stock: at a Bob Little warehouse

R = 1,500 jackets/ week

Hedge against demand uncertainty with safety stock

The standard Normal distribution F(z)

Transform back, knowing z*: X* = + z*. Rajesh Piplani, Ph.D. 2006 67

Warehouse Inventory Costs for Bob Little

Learning Objectives: safety stocks

Safety stock increases (decreases) with an increase (decrease) in

Rajesh Piplani, Ph.D. 2006

Market One Plant Warehouse Market Two

Rajesh Piplani, Ph.D. 2006

Rajesh Piplani, Ph.D. 2006

Centralization at Bob Little

Rajesh Piplani, Ph.D. 2006

Centralize Low Safety Stock High Service Level

Learning Objectives: Risk Pooling

Rajesh Piplani, Ph.D. 2006

To Centralize or not to Centralize

Rajesh Piplani, Ph.D. 2006

Rajesh Piplani, Ph.D. 2006

Transform back, knowing z: X = + z*. Rajesh Piplani, Ph.D. 2006 67