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Inventorymanagement
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Role of Inventory in the Supply Chain
Improve Matching of Supplyand Demand
Improved Forecasting
Reduce Material Flow Time
Reduce Waiting Time
Reduce Buffer Inventory
Economies of ScaleSupply / Demand
VariabilitySeasonal
Variability
Cycle Inventory Safety Inventory Seasonal Inventory
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Automotive supply chain: inventory profile(Source: Holweg and Miemczyk, 2002)
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Inventory categories
ABC Analysis of Inventory recognizes that inventories are not of equal value to a firm and as such all inventory should not be managed in the same way.
Dead inventory (dead stock) is a fourth category to ABC analysis which refers to product for which there is no sales during a 12 month period.
Inventory Turnover refers to the number of times that inventory is sold in a one-year period.
8-5
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Inventory classifications
Source : Slack, Operations Management, 6th, 2010Copyright © 2010 Pearson Education, Inc. 10-7
Role of Cycle Inventoryin a Supply Chain
◆ Cycle inventory is held primarily to take advantage of economies of scale in the supply chain
◆ Supply chain costs influenced by lot size:– Material cost = C– Fixed ordering cost = S– Holding cost = H = hC (h = cost of holding $1 in inventory for one year)
◆ Primary role of cycle inventory is to allow different stages to purchase product in lot sizes that minimize the sum of material, ordering, and holding costs
◆ Ideally, cycle inventory decisions should consider costs across the entire supply chain, but in practice, each stage generally makes its own supply chain decisions – increases total cycle inventory and total costs in the supply chain
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Estimating Cycle Inventory Related Costs in Practice
◆Inventory Holding Cost– Obsolescence– Handling costs– Occupancy costs– Theft, security, damage, tax, insurance
◆Ordering Cost– Buyer time
– Transportation costs– Receiving costs– Unique other costs
10-8
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When to Order
Fixed order quantity system
Fixed order interval system
Reorder (trigger) point (ROP)ROP = DD x RC under certainty
ROP = (DD x RC) + SS under uncertainty
Where DD = daily demand
RC = length of replenishment cycle
SS = safety stock
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Economies of Scaleto Exploit Fixed Costs
How do you decide whether to go shopping at a convenience store or at a discounter ?
Lot sizing for a single product (EOQ)
Aggregating multiple products in a single order
Lot sizing with multiple products or customersLots are ordered and delivered independently for each product
Lots are ordered and delivered jointly for all products
Lots are ordered and delivered jointly for a subset of products
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Inventory level and replenishment
Source : Slack, Operations Management, 6th, 2010Copyright © 2010 Pearson Education, Inc.
Two alternative inventory plans with different order quantities
Source : Slack, Operations Management, 6th, 2010
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Traditional view of inventory related costs
Source : Slack, Operations Management, 6th, 2010Copyright © 2010 Pearson Education, Inc.
Economic Order Quantity
Economic order quantity is the level of inventory that minimizes the total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models.
1. The ordering cost is constant.
2. The rate of demand is constant
3. The purchase price of the item is constant
4. The whole batch is delivered at once.
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Fixed Costs: Optimal Lot Sizeand Reorder Interval (EOQ)
D:Annual demand S: Setup or Order CostC:Cost per unith: Holding cost per year as a
fraction of product costH:Holding cost per unit per yearQ:Lot Size, Q*: Optimal Lot Sizen*: Optimal order frequencyMaterial cost is constant and therefore
is not considered in this model S
DhCn
H
DSQ
hCH
2*
2*
=
=
=
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EOQ calculation
24.1240002
5002.012000*
9802.0500
4000120002*
==
==
x
xxn
x
xxQ
Demand, D = 12,000 computers per year
Unit cost, C = $500
Holding cost is 20% of unit cost, h = 0.2
Fixed cost, S = $4,000/order
Cycle inventory = Q*/2 = 490
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EOQ Cost Calculations
8-19 Source : Slack, Operations Management, 6th, 2010
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Aggregating Multiple Productsin a Single Order
◆ Transportation is a significant contributor to the fixed cost per order◆ Can possibly combine shipments of different products from the
same supplier– same overall fixed cost– shared over more than one product
– effective fixed cost is reduced for each product– lot size for each product can be reduced
◆ Can also have a single delivery coming from multiple suppliers or a single truck delivering to multiple retailers
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Delivery Options
No Aggregation: Each product ordered separately
Complete Aggregation: All products delivered on
each truck
Tailored Aggregation: Selected subsets of products
on each truck
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Quantity Discounts
◆Lot size based– All units
– Marginal unit
◆Volume based
◆How should buyer react?◆What are appropriate discounting schemes?
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Short-Term Discounting: Trade Promotions
◆ Trade promotions are price discounts for a limited period of time (also may require specific actions from retailers, such as displays, advertising, etc.)
◆ Key goals for promotions from a manufacturer’s perspective:– Induce retailers to use price discounts to increase sales– Shift inventory from the manufacturer to the retailer and customer– Defend a brand against competition– Goals are not always achieved by a trade promotion
◆ What is the impact on the behavior of the retailer and on the performance of the supply chain?
◆ Retailer has two primary options in response to a promotion:– Pass through some or all of the promotion to customers to spur sales– Purchase in greater quantity during promotion period to take advantage of
temporary price reduction, but pass through little savings to customers
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Role of Safety Inventory
◆Average inventory is cycle inventory plus safety inventory
◆There is a fundamental tradeoff:– Raising the level of safety inventory provides higher levels
of product availability and customer service
– Raising the level of safety inventory also raises the level of average inventory and therefore increases holding costs
» Very important in high-tech or other industries where obsolescence is a significant risk (where the value of inventory, such as PCs, can drop in value)
» Compaq and Dell in PCs
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Determining the AppropriateLevel of Safety Inventory
◆Measuring demand uncertainty◆Measuring product availability◆Replenishment policies◆Evaluating cycle service level and fill rate◆Evaluating safety level given desired cycle service
level or fill rate
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Measuring Product Availability
◆Product availability: a firm’s ability to fill a customer’s order out of available inventory
◆Stockout: a customer order arrives when product is not available
◆Product fill rate: fraction of demand that is satisfied from product in inventory
◆Order fill rate: fraction of orders that are filled from available inventory
◆Cycle service level: fraction of replenishment cycles that end with all customer demand met
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Replenishment Policies
◆Replenishment policy: decisions regarding when to reorder and how much to reorder
◆Continuous review: inventory is continuously monitored and an order of size Q is placed when the inventory level reaches the reorder point ROP
◆Periodic review: inventory is checked at regular (periodic) intervals and an order is placed to raise the inventory to a specified threshold (the “order-up-to” level)
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Importance of the Levelof Product Availability
◆ Product availability measured by cycle service level or fill rate◆ Also referred to as the customer service level◆ Product availability affects supply chain responsiveness◆ Trade-off:
– High levels of product availability � increased responsiveness and higher revenues
– High levels of product availability � increased inventory levels and higher costs
◆ Product availability is related to profit objectives, and strategic and competitive issues
◆ What is the level of fill rate or cycle service level that will result in maximum supply chain profits?
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Factors Affecting the Optimal Level of Product Availability
◆Cost of overstocking◆Cost of understocking◆Possible scenarios
– Seasonal items with a single order in a season– One-time orders in the presence of quantity discounts
– Continuously stocked items– Demand during stockout is backlogged– Demand during stockout is lost
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Managerial Levers to Improve Supply Chain Profitability
◆“Obvious” actions– Increase salvage value of each unit (for example selling
leftover units to outlet stores)
– Decrease the margin lost from a stockout (backup sourcing)
◆Improved forecasting◆Quick response◆Postponement◆Tailored sourcing
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Improved Forecasts
◆Improved forecasts result in reduced uncertainty◆Less uncertainty results in either:
– Lower levels of safety inventory (and costs) for the same level of product availability, or
– Higher product availability for the same level of safety inventory, or
– Both lower levels of safety inventory and higher levels of product availability
An increase in forecast accuracy decreases both the overstocked and understocked quantity and increases a firm’s profits.
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Quick Response◆ Set of actions taken by managers to reduce lead time◆ Reduced lead time results in improved forecasts
– Typical example of quick response is multiple orders in one season for retail items (such as fashion clothing)
– For example, a buyer can usually make very accurate forecasts after the first week or two in a season
– Multiple orders are only possible if the lead time is reduced – otherwise there wouldn’t be enough time to get the later orders before the season ends
◆ Benefits:– Lower order quantities � less inventory, same product availability– Less overstock– Higher profits
If quick response allows multiple orders in the season, profits increase and the overstock quantity decreases.
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Postponement
◆ Delay of product differentiation until closer to the time of the sale of the product
◆ All activities prior to product differentiation require aggregate forecasts more accurate than individual product forecasts
◆ Individual product forecasts are needed close to the time of sale – demand is known with better accuracy (lower uncertainty)
◆ Results in a better match of supply and demand◆ Valuable in e-commerce – time lag between when an order is placed and
when customer receives the order (this delay is expected by the customer and can be used for postponement)
◆ Higher profits, better match of supply and demand
Postponement allows a firm to increase profits and better match supply and demand if the firm produces a large variety of products whose demand is not positively correlated and is of about the same size.
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Tailored Sourcing
◆A firm uses a combination of two supply sources◆One is lower cost but is unable to deal with
uncertainty well◆The other is more flexible, and can therefore deal
with uncertainty, but is higher cost◆The two sources must focus on different capabilities◆Depends on being able to have one source that faces
very low uncertainty and can therefore reduce costs◆Increase profits, better match supply and demand
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Setting Optimal Levels ofProduct Availability in Practice
◆Use an analytical framework to increase profits◆Beware of preset levels of availability◆Use approximate costs because profit-maximizing
solutions are very robust◆Estimate a range for the cost of stocking out◆Ensure levels of product availability fit with the
strategy
Lean manufacturing
Activities that consume time, resources and space, but do not contribute to satisfying customer needs.
� Over-production� Waiting time� Transport� Process� Inventory� Motion� Defectives
Lean focuses on the elimination of waste and the increase of speed an flow.
The 7 wastes
Source : Slack, Operations Management, 6th, 2010
seen from an operations improvement perspective
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Demand-driven Value Networks
◆Assess cost versus risk across an end-to-end value network
◆Multi-enterprise collaboration and visibility◆Supply chain event management◆Total cost to serve (CTS) analysis helps with
understanding all the waste across the value network