Supply Chain Management

• Bullwhip effect
• demand information is distorted as it moves away
from the end-use customer
• higher safety stock inventories to are stored to
compensate
• Seasonal or cyclical demand
• Inventory provides independence from vendors
• Take advantage of price discounts
• Inventory provides independence between
stages and avoids work stoppages

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-1
 Types of Inventory Two Forms of Demand

• Raw materials • Dependent

• Purchased parts and • Demand for items used to
produce final products
supplies
• Tires for autos are a
• Work-in-process (partially dependent demand item
completed) products (WIP) • Independent
• Items being transported • Demand for items used
by external customers
• Tools and equipment
• Cars, appliances,
computers, and houses
are examples of
independent demand
inventory

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-2
 Inventory Costs

• Carrying cost
• cost of holding an item in inventory
• Ordering cost
• cost of replenishing inventory
• Shortage cost
• temporary or permanent loss of sales when
demand cannot be met

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-3
 Inventory Control Systems
• Continuous system (fixed-order-quantity)
• constant amount ordered when inventory declines to
predetermined level
• Periodic system (fixed-time-period)
• order placed for variable amount after fixed passage
of time

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-4
 ABC Classification
• Class A
• 5 – 15 % of units
• 70 – 80 % of value
• Class B
• 30 % of units
• 15 % of value
• Class C
• 50 – 60 % of units
• 5 – 10 % of value

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-5
 ABC Classification
PART UNIT COST ANNUAL USAGE
1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-6
 ABC Classification
TOTAL % OF TOTAL % OF TOTAL
PART VALUE VALUE QUANTITY % CUMMULATIVE
9 $30,600 35.9 6.0 6.0
8 16,000 18.7 5.0 11.0
2 14,000 16.4 4.0
A 15.0
1 5,400 6.3 9.0 24.0
4 4,800 5.6 6.0 B 30.0
3 3,900 4.6 13.0 43.0
6 3,600 4.2 18.0 61.0
5 3,000 3.5 13.0 71.0
10 2,400 2.8 12.0 C 83.0
7 1,700 2.0 17.0 100.0
$85,400

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-7
 ABC Classification

% OF TOTAL % OF TOTAL
CLASS ITEMS VALUE QUANTITY
A 9, 8, 2 71.0 15.0
B 1, 4, 3 16.5 28.0
C 6, 5, 10, 7 12.5 60.0

Example 10.1
© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-8
 Economic Order Quantity (EOQ) Assumptions of Basic EOQ Model
Models

• EOQ
• continuous inventory system • Demand is known with certainty and is
constant over time
• optimal order quantity that will
• No shortages are allowed
minimize total inventory costs
• Lead time for the receipt of orders is
• Basic EOQ model constant
• Production quantity model • Order quantity is received all at once
• Order cycle
• the time between receipt of orders in
an inventory system

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-9
 Inventory Order Cycle

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-10
 EOQ Cost Model

Co - cost of placing order D - annual demand

Cc - annual per-unit carrying cost Q - order quantity

CoD
Annual ordering cost =
Q
CcQ
Annual carrying cost =
2
CoD CcQ
Total cost = +
Q 2

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-11
 EOQ Cost Model

Deriving Qopt Proving equality of

costs at optimal point
CoD CcQ
TC = +
Q 2 CoD CcQ
=
TC Co D Cc Q 2
= – Q2 +
Q 2
2CoD
C0D Cc Q2 =
Cc
0 = – Q2 +
2
2CoD
2CoD Qopt =
Qopt = Cc
Cc

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-12
 EOQ Cost Model

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-13
 EOQ Example

Cc = $0.75 per gallon Co = $150 D = 10,000 gallons

2CoD CoD CcQ

Qopt = TCmin = +
Cc Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = (0.75) TCmin = 2,000 + 2

Qopt = 2,000 gallons TCmin = $750 + $750 = $1,500

Orders per year = D/Qopt Order cycle time = 311 days/(D/Qopt)

= 10,000/2,000 = 311/5
= 5 orders/year = 62.2 store days

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-14
 Production Quantity Model
• Order is received gradually, as inventory is
simultaneously being depleted
• non-instantaneous receipt model
• assumption that Q is received all at once is relaxed
• p - daily rate at which an order is received over
time, the production rate
• d - daily rate at which inventory is demanded

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-15
 Production Quantity Model

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-16
 Production Quantity Model

p = production rate d = demand rate

Maximum inventory level = Q - Q d

p

=Q1- d 2CoD
p
Qopt = d
Q d Cc 1 -
Average inventory level = 1- p
2 p

CoD CcQ d
TC = Q + 2 1 - p

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-17
 Production Quantity Model
Cc = $0.75 per gallon Co = $150 D = 10,000 gallons
d = 10,000/311 = 32.2 gallons per day p = 150 gallons per day

2CoD
Qopt = =
Cc 1 - d
p

CoD CcQ d
TC = Q + 2 1 - p =

Q
Production run = =
p

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-18
 Production Quantity Model

D
Number of production runs = =
Q

d
Maximum inventory level = Q 1 - =
p

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-19
 Production Quantity Model
Cc = $0.75 per gallon Co = $150 D = 10,000 gallons
d = 10,000/311 = 32.2 gallons per day p = 150 gallons per day

2CoD 2(150)(10,000)
Qopt = = = 2,256.8 gallons
Cc 1 - d 0.75 1 -
32.2
p 150

CoD CcQ d
TC = Q + 2 1 - p = $1,329

Q 2,256.8
Production run = = = 15.05 days per order
p 150

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-20
 Production Quantity Model

D 10,000
Number of production runs = = = 4.43 runs/year
Q 2,256.8

d 32.2
Maximum inventory level = Q 1 - = 2,256.8 1 -
p 150
= 1,772 gallons

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-21
 Quantity Discounts

Price per unit decreases as order

quantity increases
CoD CcQ
TC = + + PD
Q 2
where
P = per unit price of the item
D = annual demand

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-22
 Quantity Discount Model

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-23
 Quantity Discount
QUANTITY PRICE
Co = $2,500
1 - 49 $1,400 Cc = $190 per TV
50 - 89 1,100 D = 200 TVs per year
90+ 900

2CoD
Qopt = =
Cc

For Q = CoD CcQopt

TC = + 2 + PD =
Qopt

For Q = 90 CoD CcQ

TC = + 2 + PD =
Q

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-24
 Quantity Discount
QUANTITY PRICE
Co = $2,500
1 - 49 $1,400 Cc = $190 per TV
50 - 89 1,100 D = 200 TVs per year
90+ 900

2CoD 2(2500)(200)
Qopt = = = 72.5 TVs
Cc 190

For Q = 72.5 CoD CcQopt

TC = + 2 + PD = $233,784
Qopt

For Q = 90 CoD CcQ

TC = + 2 + PD = $194,105
Q

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-25
 Reorder Point
• Inventory level at which a new order is placed

R = dL
where

d = demand rate per period

L = lead time

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-26
 Reorder Point

Demand = 10,000 gallons/year

Store open 311 days/year
Daily demand =
Lead time = L = 10 days

R = dL =

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-27
 Reorder Point

Demand = 10,000 gallons/year

Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154
gallons/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 gallons

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-28
 Safety Stock
• Safety stock
• buffer added to on hand inventory during lead time
• Stockout
• an inventory shortage
• Service level
• probability that the inventory available during lead
time will meet demand
• P(Demand during lead time <= Reorder Point)

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-29
 Reorder Point With Variable Demand

R = dL + zd L
where
d = average daily demand
L = lead time
d = the standard deviation of daily demand
z = number of standard deviations
corresponding to the service level
probability
zd L = safety stock

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-30
 Reorder Point For a Service Level

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-31
 Reorder Point For Variable Demand

The paint store wants a reorder point with a 95%

service level and a 5% stockout probability
d = 30 gallons per day
L = 10 days
d = 5 gallons per day

For a 95% service level, z = 1.65

R = dL + z d L Safety stock = z d L

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-32
 Reorder Point For Variable Demand

The paint store wants a reorder point with a 95%

service level and a 5% stockout probability
d = 30 gallons per day
L = 10 days
d = 5 gallons per day

For a 95% service level, z = 1.65

R = dL + z d L Safety stock = z d L
= 30(10) + (1.65)(5)( 10) = (1.65)(5)( 10)
= 326.1 gallons = 26.1 gallons

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-33
 Order Quantity for a
Periodic Inventory System

Q = d(tb + L) + zd tb + L - I

where
d = average demand rate
tb = the fixed time between orders
L = lead time
d = standard deviation of demand
zd tb + L = safety stock
I = inventory level

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-34
 Periodic Inventory System

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-35
 Fixed-Period Model With
Variable Demand
d = 6 packages per day
d = 1.2 packages
tb = 60 days
L = 5 days
I = 8 packages
z = 1.65 (for a 95% service level)

Q = d(tb + L) + zd tb + L - I
= (6)(60 + 5) + (1.65)(1.2) 60 + 5 - 8
= 397.96 packages

© 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e 13-36