Supply Chain Inventory

Management
Multi-period Problems
Read: Chap 10.1-10.2.
Chap 11.

Push vs. Pull Processes

PUSH: Order decision initiated in anticipation to customer
orders
A newspaper vendor orders first, then sells
Bossini decided quantity of mens pants 3 mos before the
season
PULL: Order decision initiated in response to customer
orders/demand
A restaurant first takes orders, then makes
Parkn Shop replenishes a detergent item, cos stock level
is low
Push-Pull Boundary
The restaurant must buy materials first -- push

Pull/Push SC Processes
A push/pull boundary in a SC separates push from
pull processes
Typically upper stream push while down stream
pull
Examples
Parkn Shop (stores: pull )
Campbells soup (procurement & production -- push)

Textbook 1.5

Defining concepts put aside

Assemble-to-order (build-to-order)
You start assembly operations only after you have received
the order
Often, you have the materials/subassemblies ready
Dell has all the materials made ready by its suppliers,
then batch assembles to the orders
Make-to-order (build-to-order)
You start processing the order after you receive it
Typically, you do not have materials ready until the order
arrives
Most apparel subcontract manufacturers run in this
mode
Which mode takes a longer lead time to finish the order?

Decisions
When to order?
In what quantity?
How to get the order delivered?
From whom?
Prices?

SKU: Stock keeping unit the decision unit

Two Inventory
Decisions/Replenishment Rules
How much to order / produce?
Order quantity -- e.g., OUT, EOQ,

When to order / produce?

Reorder points, time periods
Use Safety Stock to cope with uncertainty

Multiple Period Problems

Inventory may be sold/used and replenished in
multiple periods - multiple period inventory
problem
What is the major difference between this and the
newsboy problem ?
You can carry inventory from one period to the next
Backlogging your demand is possible (but at some
intangible cost)

Two popular types of systems: periodic review

and continuous replenishment

Periodic v.s. Continuous Review

Periodic review model
Common for B & C items
Economy of scales
Continuous review model
Slow moving items or
Important items

When periodic/continuous review?

Inventory policy: when and how
much to order - tactical level

Two Inventory Decisions

How much to order / produce?
Order quantity -- e.g., OUT, EOQ,

When to order / produce?

Reorder points, time periods
Use Safety Stock to cope with uncertainty

Inventory Costs
Order/Set-up costs
Trucking, receiving, inspection, calls, faxes,
GE estimated the cost of processing a typical Diminishing
over time
replenishment order is about $50
Trucking cost a major part

Holding costs
Stock-out / shortage /underage cost
Salvage value

Inventory Holding Costs

% of
Category
Inventory Value
Housing (building) cost
6%
Material handling costs
3%
Labor cost
3%
Inventory investment costs
11%
Pilferage, scrap, & obsolescence
3%
Total holding cost
26%

EOQ Assumptions
Known & constant demand
Known & constant lead time
Instantaneous receipt of material (or constant
leadtime)

No quantity discounts
Only order (setup) cost & holding cost
No stockouts
Price is pre-fixed

EOQ Model:
How Much to Order?
Annual Cost

Total Cost Curve

Holding Cost
Order (Setup) Cost

Optimal
Order Quantity (Q*)

Order Quantity

EOQ Model:
When to Order?

Cycle
Inventory!

Inventory Level
Optimal
Order
Quantity
(Q*)

Average
Inventory (Q*/2)

Reorder
Point
(ROP)
Lead Time

Time

The EOQ Formula

Economic
order quantity

EOQQ* 2DK
hc

Where:
D = annual demand (units)
K = setup cost/order
h = carrying charge ($/unit/year)
c = unit cost ($/unit)

Total cost = order cost + carrying cost

TC = c D +(D/Q)K+ (Q/2 ) h c

Optimal fixed order quantity

The Key Insight of EOQ

1. There is a tradeoff between lot size and inventory

2. Holding and setup costs are fairly insensitive to lot
size Q
TC(Q*) = cD +(D/Q)K+ (Q/2 ) h c
=> Sqrt (2 D*K*h*c)
Q -> TC(Q)/TC(Q*) = [Q/Q* + Q*/Q]/2
e.g., Q = 2Q*, TC(Q)/TC(Q*) = 1.25

Textbook

Economic order quantity lot size

EOQ 2DK
hc

EOQ 2??
??

- The model is insensitive to

parameter values and robust!

Example: Broadway
Consider inventory management for a certain SKU at Broadway.
Supply lead time is 4 days. Daily demand for the item is variable
with a mean of 30 units and a coefficient of variation of 20%.
Assume that fixed ordering cost is estimated at $50 per order,
and inventory holding costs are 15% of the product cost ($80)
per year. Also, assume that the store is open 360 days a year.
Propose an inventory policy for this SKU.
L = 4, AVG Dd = 30 per day
K = 50, hC = (0.15)(80)/360 = 0.0333 (converted to daily cost)
Use EOQ to calculate order quantity:
Q = sqrt[2(K)(AVG)/(hc)] = sqrt[2(50)(30)/0.0333] = sqrt(90000) = 300

Multiple Products/Items
The setup cost can be shared among
different products/items
Replenish all jointly
Replenish a subset each time

Order
quty

All jointly
together

Time

Subset jointly
together

Problems with EOQ?

Deterministic demand?

Moving to random/uncertain demand

What will happen to the above EOQ charts?

First consider a single product/item

Shortage/Underage Costs
Emergency ordering, loss of goodwill, lost
sales, hurting return buz.
In multiple periods, they are notoriously
difficulty to estimate

Shortage/stockout occurs, whatll happen?

Lost-sales or backlogging/backordering

Throughout, we assume backordering

Performance Evaluation of
Material/Dist Mgt
Imagine you are a distribution manager,
youre responsible for delivery of products
to sales outlets - mkting gets customer &
you deliver. How should you be evaluated?
Costs are clearly most relevant. But how to estimate
shortage costs?

Service Levels
Inventory related service performance measurements
Fill rate: fraction of demand being filled right away
e.g., over past 52 wks, customer orders: 120,500 units,
filled upon arriving: 110,050 units => customer
backorders = 10,450. Fill rate = 0.91.
Ready rate: % of periods (or times) that there is no stock
out - filling all the demand arriving in the periods (or upon
arriving); e.g.,
among the past 52 wks (or orders), in 47 wks (or orders), no stockout, ready rate = 90%. In your textbook, it is called Cycle
Service Level (CSL).

Item/Line-based service levels

Line and Order Based Service Levels

Line/item based or item based service level: for only
one SKU or similar SKUs.
Order based: a customer order may request a
number of different SKUs - lines - with varying #.
Throughout this course, we mean item/line service
level.
Several Cases mention both types of service levels.

Multi-Product Availability
Service level = fill rate <= suitable?
Item-based = Line-based <=> order based

Order fulfillment rate: % times of filling

orders completely (prob. being fully fulfilled)

More about Fill/Ready Rate

Off-shelf v.s. Time-window
Off-shelf : instant availability
Time-window : available or delivered within a
certain time - ready rate within TW

We confine ourselves within off-shelf fill

/ready rates , item-based

Service Level
Line/Item Based

In-stock %, Cycle Service Level

Off-shelf

Window Based

Order Based

Fill rate

APPROPRIATE LEVEL
$
TC
SALES

CSL

Demands are uncertain!

Order point system (R,Q)

Inventory position (effective inventory level =

on hand + on order backorders (or allocated)

Rule: Whenever the inventory position goes

below the reorder point R then order a fixed
quantity Q.
Best known as Reorder Point &
Batch Size Policy

Order point system (R,Q)

Two bin system ...

B
Rule: when the big bin is empty, open the
small bin and place an order.

Inventory Level

Freq

Max.
X

Place
order

Lead Time

Receive
order

Time

DDLT=demand during leadtime

Inventory Level

Freq

Max.
SS

Aver. DDLT
Safety Stock (SS)
Place
order

Lead Time

Receive
order

Time

Ave. Inventory

CYCLE
SAFETY
TIME

How to determine (ROP, Q)?

Lot size Q by EOQ
ROP by a service level specification
Key assumption here is the same demand
pattern over many periods or long time

Inventory Level

Freq

Max.
SS

ROP

Aver. DDLT
Safety Stock (SS)
Place
order

Lead Time

Receive
order

Time

An Example
Youre a buyer for General
Hospital. The demand for
hospital ER kits is normally
distributed. The mean demand
during the reorder period is 350
kits, with = 10 kits. The
hospital wants stockouts no more
than 5% of the time. What are
the safety stock & ROP?

Solution
Frequency
= 10

Svc Level = .95

P(Stockout) = .05

= 350

Safety Stock = x -

x=?

Solution
Safety stock x
x
From statistics , z

Therefore, z

Safety stock

& Safety stock z

From normal table, z.95 1.65

Safety stock z 1.65 10 16.5
ROP Safety stock
350 16.5 366.5 367
If sigma is bigger or leadtime longer, then SS ?

Other Continuous Systems

Sell one then replenish one
( )
Extended reorder-point, lot-size system
(r, nQ): r=ROP

Min Max policy (system )

Eff. Inventory Level

Max.
=ROP+Q
ROP

Place
order

Lead Time

Receive
order

Time

Periodic Review Systems

Order up-to model definitions
On-order inventory / pipeline inventory = the number of units that have been
ordered but have not been received.
On-hand inventory = the number of units physically in inventory ready to
serve demand.
Backorder = the total amount of demand that has has not been satisfied:
All backordered demand is eventually filled, i.e., there are no lost sales.
Inventory level = On-hand inventory - Backorder.
Inventory position = On-order inventory + Inventory level.
Order up-to level, S
the maximum inventory position we allow.
sometimes called the base stock level.
13-42

When and how much is ordered?

Inventory Level

Target maximum

Aver. Demand

SS

Period Period Period

Time

Periodic Review
Ordering every period
SS = Reorder point (level) Aver. DDLT

Can (r, Q) policy work properly?

Min Max policy (system)

Multi-Item System Control

Coordination is required for multiple product
ordering. Why?
One policy is (Min, c, Max) : can-order

Item A

Item B
Max

Max

c Can-order
c Can-order
ROP MIN

ROP MIN

What learnt here?

Two review/auditing systems
Several ordering rules/policies
How are the question of when and how much to
order in each of this systems-policies answered?
Reorder point/level can be determined by a service
level requirement/specification
The concept of safety stock

Managerial Insights
Insight 1: the higher variability of demand, the higher SS.

Insight 2: Shorter leadtime will result in lower SS

Insight 3: When supply and/or leadtime is uncertain, SS?