Supply Chain

Management
Sessions 13, 14
Amit Sharan Jain

December 2017
Inventory Management

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Safety Stock
• Inventory carried for the purpose of satisfying demand that exceeds
the amount forecasted in a given period

• Trade-off
• Higher levels of product availability and customer service
• Higher level of average inventory and therefore increases holding costs

• Most important questions

• What is the appropriate level of safety stock?
• What actions help in reducing safety stock while improving product
availability?

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 Calculating appropriate safety stock
Safety Stock

Z √ ( σD2 L + D2 σL2 )

Product availability Demand uncertainty Supply uncertainty

Z = Norminv (CSL) √ (σD2 L) √ D 2 σL 2

where, where, where,

CSL = Cycle Service σD = Standard deviation of σL = Standard deviation of
Level demand for a period lead time
L = Average Lead Time D = Average Demand for a
period

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Safety stock calculation:
Example
Motorola obtains cell phones from its contract manufacturer located
in China to serve the US market. The US market is served from a
Warehouse in Memphis, Tennessee. Daily demand at the Memphis
warehouse is normally distributed with a mean of 5000 and a standard
deviation of 4000. The warehouse aims for a CSL of 99 percent. The
company is debating whether to use sea and air transportation from
china. Sea transportation results in a lead time of 36 days and costs
$0.50 per phone. Air transportation results in a lead time of 4 days and
costs $1.50 per phone. Each phone costs $100 and Motorola uses
holding costs of 20 percent. Given the minimum lot sizes, Motorola
would order 100,000 phones at a time (on average, once every 20
days) if using sea transport and 5000 phones at a time (on average,
daily) if using air transport. Warehouse works 365 days in a year. (
NORMINV(0.99 ) = 2.33 )

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Safety stock calculation:
Example solution
Z √ ( σD 2 L + D 2 σL 2 )
Z = Norminv(CSL) = Norminv (0.99) = 2.33
σD = 4000, σL = 0

Sea transportation Air transportation

• Lead time, L = 36 days • Lead time, L = 4 days
• Safety stock = 2.33 * √ (36 ∗ 40002) • Safety stock = 2.33 * √ (4 ∗ 40002)
= 55,920 = 18,640
• Holding cost for safety stock • Holding cost for safety stock
= SS * h*C = SS * h*C
= $1,118,400 = $372,800
• Ordering cost for SS# = SS*0.5 • Ordering cost for SS # = SS*1.5
= $559,200 = $559,200

# Assumption for Ordering Cost: Safety stock is built-up during the start of the year and
maintained thereafter.
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Calculations for annual ordering and holding cost for cycle stock depicted in earlier session
Steps to reduce safety stock levels
Z √ ( σD2 L + D2 σL2 )

• Optimize service levels (Z)

• Product criticality
• A-B-C Classification
• Customer classification
• Reduce average lead time (L)
• Production response time and flexibility
• Transportation modes
• Proximity of production and consumption points
• Reduce demand uncertainty (σD)
• Market intelligence
• Scientific forecasting methods
• Supply chain visibility
• Reduce supply uncertainty (σL)
• Scientific production and transportation planning
• Visibility of future demand to suppliers 7
Aggregation of inventory and impact on
safety stock
• A supply chain has varying degrees of inventory aggregation for
different products

• Many e-commerce retailers attempt to take advantage of aggregation

(Amazon) compared to brick-and-mortar retailers (Walmart)

• Aggregation has two major disadvantages:

• Increase in response time to customer order
• Increase in transportation cost

• Aggregation leads to a decrease in the total safety stock carried for a

supply chain

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Safety stock in an aggregated model
• Suppose there are n regions, with demand in each region being independent and
normally distributed
• Di : Mean period demand for each region i, i = 1,…,n
• σi : Standard deviation of period demand in region i, i = 1,…,n

Decentralized option Centralized option

• Local inventories are maintained in
each region
• Safety stock is the sum of safety
stocks for individual regions
Z √ ( σι2 L)
• Aggregate all inventories in a single
location
• Mean period demand,
• Standard deviation of demand

• Safety stock, SS =

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Safety stock in an aggregated model:
Example 1
ABC Inc. produces printers in its Chinese factory for sale in SAARC countries.
Currently, ABC Inc. assembles and packs printers for direct sale in individual SAARC
countries. The distribution of weekly demand in different countries is normally
distributed with means and standard deviation as follows:
Country Mean Standard Deviation
Sri Lanka 3000 2000
Nepal 2500 1600
Bhutan 1000 800
India 4000 2400
Assume demand in different countries to be independent and the lead time from
manufacturing factory is eight weeks. The company follows continuous
replenishment policy. ABC Inc. decides to build a central DC in one of the SARRC
countries and shall now ship printers directly to this DC. Deliveries to individual
countries shall be from DC. The printers are still manufactured in China with a lead
time of eight weeks.
How much total safety inventory does ABC Inc. require for all SAARC countries if it
targets a CSL of 95 percent? 10
Safety stock in an aggregated model:
Example 1 solution
• CSL = 95%
• Z = Norminv (95%) = 1.64
• Lead time in weeks = 8

Decentralized option Centralized option

Country Mean Standard Safety • Standard deviation of demand,
Deviation stock
Sri Lanka 3000 2000 9,277
= √ (20002+16002+8002+24002)
Nepal 2500 1600 7,422
= 3600
Bhutan 1000 800 3,711 • Safety stock =
India 4000 2400 11,133
= (1.64) (√ 8) (3600)
Total 31,543
= 16,699

Note: If number of independent stocking locations decreases by n, the expected level of

safety inventory will be reduced by square root of n
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Safety stock in an aggregated model:
Example 2 (ex. 12.12)
A paint retailer sells 100 different colors of paint. Weekly demand for each colour
Is normally distributed with mean of 30 units and standard deviation of 10 units.
Assume the demand of a colour is independent from the demand of other colours.
The replenishment lead time from factory is 2 weeks and retailer aims for a 95%
CSL. How much safety stock will the retailer have to hold if paints are mixed in
factory and held in inventory at the retailer. How does the safety stock of the
requirement change if the retailer holds base paint and mixes colour on demand.

Disaggregated option Centralized option

• Standard deviation of demand • Standard deviation of demand,
= Z √ ( σ 2 L)
ι

= √ (100 * 102)
= 100 * Norminv(0.95) * √ (10 ∗2)
2
= 100
= 2,326 units
• Safety stock =
= (1.64) (√ 2) (100) = 233 units
Note: Since the number of stocking units have reduced by a factor of 100, the safety
stock has reduced by a factor of 10 (viz.√ 100) 12
Supply Chain
Coordination

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Supply chain coordination
• All stages in the supply chain take actions that are aligned and
increase total supply chain surplus

• SC coordination requires that each stage share information and take

into account the effects of its actions on the other stages

• Lack of coordination results when:

• Little or incorrect information shared between stages
• Conflict in objectives of different stages

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Bull-whip effect
• Fluctuations in orders
increase as they move up
the supply chain from
retailers to
manufacturers

• Distorts demand
information within the
supply chain

• Results in a loss of supply

chain coordination

Whipped Beer Simulation Game: https://www.learnbizsimulations.com/

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Impact of lack of coordination
Performance Measure Impact of the Lack of Coordination
Manufacturing cost Increases
Inventory cost Increases
Replenishment lead time Increases
Transportation cost Increases
Shipping and receiving cost Increases
Level of product availability Decreases
Profitability Decreases

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Obstacles to Coordination
Incentive Obstacles
• Local optimization
• Sales force incentives

Information Processing Obstacles

• Forecasting based on orders from a supply chain stage instead of demand
• Lack of information sharing

Operational Obstacles
• Large lots
• Large replenishment lead times
• Rationing and shortage gaming

Pricing Obstacles
• Lot-sized based quantity decisions
• Price fluctuations leading to forward buying 17
Achieving Supply Chain Coordination
Aligning Goals and Incentives
• Incentives to maximize supply chain surplus
• Align incentives across functions
• Pricing for coordination
• Change sales force incentives from retailer demand to customer demand

Designing Pricing Strategies to Stabilize Orders

• Reduce forward buying
• Volume-based discounting instead of lot-based discounting
• Stabilize prices
• Building Strategic Partnerships and Trust

Improving Information Accuracy

• Sharing POS data
• CPFR
• Single stage control of replenishments
• CRP: POS data / retailer warehouse data based regular replenishment by
wholesaler or manufacturer, inventory owned by retailer
• VMI: Vendor (manufacturer / supplier) responsible for all inventory decisions, 18
inventory may / may not be owned by retailer
Collaborative Planning, Forecasting, and
Replenishment (CPFR)
“A business practice that combine the intelligence of multiple
partners in the planning and fulfillment of customer demand”
- VICS Association

Sellers and buyers in a supply chain may collaborate along any or all of
the following:
• Strategy and planning: Scope of collaboration incl. roles,
responsibilities, extent and time period
• Demand and supply management: Forecasting
• Execution: Order placement to fulfillment
• Analysis: Exceptions and metrics assessment

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 Common CPFR Scenarios
Where Applied in
CPFR Scenario
Supply Chain
Retail event collaboration Highly promoted channels
or categories
Industries Where
Applied
All industries other than
those that practice EDLP

DC replenishment Retail DC or distributor DC Drugstores, hardware,

collaboration grocery

Store replenishment Direct store delivery or Mass merchants, club

collaboration retail DC-to-store delivery stores

Collaborative assortment Apparel and seasonal goods Department stores,

planning specialty retail

Question: What are the benefits of CPFR?

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CPFR: Requirements and Risks
Requirements
• Organizational re-alignment to customer- or geography-specific
needs
• Technology enabler for timely and accurate information sharing

Risks
• Misuse of information
• Frequent alignment of technology
• Cultural mismatch
• Selection of right level of coordination
• Initiate CPFR with DC-level or event-level before moving to store-level

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Transportation

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Stakeholders
• Infrastructure providers
• Transportation Policy-makers
• Shipper (1PL)
• Transportation, inventory, information, sourcing and facility costs
• Carrier (2PL)
• Transportation equipment costs
• Operating costs
• 3rd Party (3PL)
• Outsourced logistics services provider
• 4th Party (4PL)
• Takes over a function (such as transportation, warehousing etc.)
• Manages 3PLs

Then there were other parties such as 5PL, 6PL, … 10PL etc.

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Transportation Modes
• Air
• Rail
• Water
• Package Carriers
• Trucks
• TL
• LTL
• Pipeline
• Intermodal

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Transportation Modes
Air
• Fast and expensive
• Mostly used for small items or
time-sensitive shipments
• Costs
• Fixed infrastructure cost
• Fixed per flight costs (crew & fuel)
• Variable costs based on cargo
• Key issues
• Location/number of hubs
• Location of fleet bases/crew bases
• Schedule optimization
• Fleet assignment
• Crew scheduling
• Yield management
Package Carriers
• Companies like FedEx, UPS, etc.
• Usually carry small packages:
letters to shipments of about 150
pounds
• Use air, truck and rail modes
• Expensive
• Rapid and reliable delivery
• Value added-services such as
processing, product assembly and
package tracking
• Consolidation of shipments
• Key Issues
• Location and capacity of transfer
points
• Scheduling and routing of delivery
• IT capability to track packages
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Transportation Modes
Truck
• More expensive than rail but benefit of door delivery
• Large shipment sizes
Truckloads (FTL) Less than Truckloads (LTL)
• Low fixed costs • Suited for shipments too large for
• Key Issues package carriers
• Imbalance in inbound and • Hub-and-spoke networks
outbound flows
• Longer lead time vis-à-vis TL due to
• Utilization multiple pickups and deliveries
• Service consistency
• Empty backhauls • Key issues
• Location of consolidation facilities
• Utilization
• Vehicle routing
• Service consistency
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Transportation Modes
Water
• Limited to certain geographic
areas
• Ocean, inland waterway system,
coastal waters
• Large loads at slow speed
• Containerization
• Dominant in global trade
• Key Issues
• Delays at ports, customs and
security
• Container management
Rail
• Costs
• High fixed costs for tracks,
locomotives, cars and yards
• Trip related fixed costs such as
labour
• Variable costs based on distance, # of
cars etc.
• Used for large, heavy or
high-density products (such as
commodities) over long distances
• Key Issues
• Utilization of crew and locomotives
• On-time performance due to track
and terminal delays
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Transportation Modes
Pipeline
• Primarily for crude petroleum,
refined petroleum products,
natural gas
• Significant initial fixed cost
• Best for large and predictable
demand
• Not suited for sending petrol to
petrol station
Intermodal
• Use of more than one mode of
transportation
• Most common example: rail/truck
• Grown considerably with increased
use of containers
• Enabler of global trade
• Single-point-of-contact for
shippers
• Key issue
• On-time transfer of cargo from one
mode to the next

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Design options for Transportation
Networks
• Direct shipping network
• Direct shipping with milk runs
• All shipments via Intermediate DC with storage
• All shipments via Intermediate Transit Point with Cross-Docking
• Shipping via DC using milk runs
• Tailored network

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Design options for Transportation
Networks
Network Structure Pros Cons
Direct shipping No warehouse, easy to High inventories (due to
coordinate large lot sizes)
Direct shipping with milk Lower inventories Increased coordination
runs May have lower
transportation costs
All shipments via Lower inbound Increased inventory and
Intermediate DC with transportation costs increased handling at DC
storage
All shipments via Low inventory, low Increased coordination
Intermediate Transit Point inbound transportation
with Cross-Docking costs
Shipping via DC using milk May have low outbound Increased coordination
runs transportation costs
Tailored network Match of mode with Highest coordination
customer / product complexity
requirements 30
Trade-offs in Transportation Design
Transportation vs. inventory cost trade-off
• Choice of transportation mode
• Inventory costs include cycle stock, safety stock and in-transit stock
• Faster modes for products with high value / weight ratio and vice versa

• Inventory aggregation
• Aggregation reduces inventory and inbound transportation costs, but increase
outbound transportation costs
• Aggregate when value / weight ratio is high, demand uncertainty is high or
customer orders in small lot-sizes

Transportation cost vs. responsiveness trade-off

• Temporal aggregation is the process of combining orders across time
• Temporal aggregation reduces transportation cost because it results in larger
shipments and reduces variation in shipment sizes
• However, temporal aggregation reduces customer responsiveness
• Key question: Do customers value current level of responsiveness?
Choice of transportation mode:
Example
Motorola obtains cell phones from its manufacturer in China to serve
US market. The US market is serviced through a warehouse in
Memphis, Tennessee. The daily average demand at the warehouse is
5000 units. The company is debating whether to use air or sea
transportation. Sea transportation costs $0.5 per phone and air
transportation costs $1.5 per phone. Cost of phone is $100 and holding
costs are 20%. Minimum lot sizes are 100,000 phones for sea
transportation and 5000 units for air transportation. Under a
continuous review, which transportation route do you recommend?

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Role of IT in Transportation
• Required due to the complexity and scale of transportation

• Use-cases for IT applications:

• Vehicle-level routing guides
• Load optimization
• Loading patterns based on unloading sequence
• GPS applications for vehicle tracking, real-time routing suggestions, arrival
notifications etc.

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