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Management, Supply
Contracts and Risk
Pooling
Phil Kaminsky
David Simchi-Levi
kaminsky@ieor.berkeley.edu
Philip Kaminsky
Edith Simchi-Levi
Outline of the Presentation
Supply
Inventory &
warehousing
costs
Production/
purchase Transportati
on Transportati
on
costs costs Inventory & costs
warehousing
costs
Inventory
Where do we hold inventory?
– Suppliers and manufacturers
– warehouses and distribution centers
– retailers
Types of Inventory
– WIP
– raw materials
– finished goods
Why do we hold inventory?
– Economies of scale
– Uncertainty in supply and demand
– Lead Time, Capacity limitations
– Cost Structure
Order
Size
Avg. Inven
Time
© 2003 Simchi-Levi, Kaminsky, Simchi-Levi
EOQ: Calculating Total
Cost*
Purchase Cost Constant
Holding Cost: (Avg. Inven) * (Holding Cost)
80
Holding Cost
60
40
20 Order Cost
0
0 500 1000 1500
Order Quantity
Order Quantity 50% 80% 90% 100% 110% 120% 150% 200%
Cost Increase 125% 103% 101% 100% 101% 102% 108% 125%
Demand Scenarios
Probability
30%
25%
20%
15%
10%
5%
0%
0
0
00
00
00
00
00
00
80
10
12
14
16
18
Sales
Profit =
Revenue - Variable Cost - Fixed Cost + Salvage
Expected Profit
$400,000
$300,000
Profit
$200,000
$100,000
$0
8000 12000 16000 20000
Order Quantity
$400,000
$300,000
Profit
$200,000
$100,000
$0
8000 12000 16000 20000
Order Quantity
$400,000
$300,000
Profit
$200,000
$100,000
$0
8000 12000 16000 20000
Order Quantity
100%
80%
Probability
60% Q=9000
40% Q=16000
20%
0%
0
00
00
00
00
00
00
00
00
00
00
10
30
50
-3
-1
Revenue
© 2003 Simchi-Levi, Kaminsky, Simchi-Levi
Key Insights from this
Model
The optimal order quantity is not necessarily equal
to average forecast demand
The optimal quantity depends on the relationship
between marginal profit and marginal cost
As order quantity increases, average profit first
increases and then decreases
As production quantity increases, risk increases.
In other words, the probability of large gains and of
large losses increases
Selling Price=$125
Salvage Value=$20
Stores
Demand Scenarios
30%
Probability
25%
20%
15%
10%
5%
0%
00
0
0
0
00
00
00
00
00
80
10
14
16
18
12
Sales
500000
400000
300000
200000
100000
0
6000 8000 10000 12000 14000 16000 18000 20000
Order Quantity
500000
400000
300000
200000
100000
0
6000 8000 10000 12000 14000 16000 18000 20000
Order Quantity
Selling Price=$125
Salvage Value=$20
Stores
500,000
Retailer Profit
400,000
300,000
200,000
100,000
0
00
00
00
00
0
0
0
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
13
14
15
16
17
18
Order Quantity
400,000
300,000
200,000
100,000
0
00
00
00
00
0
0
0
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
13
14
15
16
17
18
Order Quantity
500,000
400,000
300,000
200,000
100,000
0
00
00
00
00
0
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
13
14
15
16
17
18
Production Quantity
500,000
400,000
300,000
200,000
100,000
0
00
00
00
00
0
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
13
14
15
16
17
18
Production Quantity
Selling Price=$125
Salvage Value=$20
Stores
600,000
500,000
Retailer Profit
400,000
300,000
200,000
100,000
0
0
0
00
00
00
00
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
13
14
15
16
17
18
Order Quantity
600,000
$504,325
500,000
Retailer Profit
400,000
300,000
200,000
100,000
0
0
0
00
00
00
00
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
13
14
15
16
17
18
Order Quantity
700,000
600,000
Manufacturer Profit
500,000
400,000
300,000
200,000
100,000
0
00
00
00
00
0
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
13
14
15
16
17
18
Production Quantity
700,000
600,000
Manufacturer Profit
500,000 $481,375
400,000
300,000
200,000
100,000
0
00
00
00
00
0
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
13
14
15
16
17
18
Production Quantity
Selling Price=$125
Salvage Value=$20
Stores
1,200,000
Supply Chain Profit
1,000,000
800,000
600,000
400,000
200,000
0
00
00
00
00
0
0
00
00
00
00
00
00
00
00
00
60
70
80
90
10
11
12
14
16
17
18
13
15
Production Quantity
1,200,000
$1,014,500
Supply Chain Profit
1,000,000
800,000
600,000
400,000
200,000
0
00
00
00
00
0
0
0
00
00
00
00
00
00
00
00
00
60
70
80
90
11
12
13
10
14
15
16
17
18
Production Quantity
Profit =
Revenue - Variable Cost - Fixed Cost + Salvage
$400,000
$300,000
Profit
$200,000
$100,000
$0
8000 12000 16000 20000
Order Quantity
500000
400000
300000
Profit
200000
100000
0
00
00
00
00
0
00
50
00
50
50
65
80
95
11
12
14
15
P roduc tion Qua ntity
500000
400000
300000
Profit
200000
100000
0
00
00
00
00
0
00
50
00
50
50
65
80
95
11
12
14
15
P roduc tion Qua ntity
500000
400000
300000
Profit
200000
100000
0
00
00
00
00
0
00
50
00
50
50
65
80
95
11
12
14
15
P roduc tion Qua ntity
200000
100000
0
5000
6000
7000
8000
9000
13000
10000
11000
12000
14000
15000
16000
P ro d u ctio n Qu an tity
Standard Deviation = 5
Standard Deviation = 10
0 10 20
Average
30
=4030 50 60
uncertainty
Balance fixed costs and holding
costs
S
Inventory Position
Inventory Level
Lead
Time
0
Time
© 2003 Simchi-Levi, Kaminsky, Simchi-Levi
The (s,S) Policy
(s, S) Policy: Whenever the inventory
position drops below a certain level, s, we
order to raise the inventory position to level
S.
The reorder point is a function of:
use?
What about the fixed cost?
L L L
Base-stock
Level Inventory
Inventory Level
Position
0
Time
© 2003 Simchi-Levi, Kaminsky, Simchi-Levi
Periodic Review Policy
components:
– Average demand during r+L days (the time until
the next order arrives):
(r+L)*AVG
– Safety stock during that time:
z*STD* √r+L
© 2003 Simchi-Levi, Kaminsky, Simchi-Levi
Risk Pooling
Market One
Supplier Warehouse
Market Two
answers?
Week 1 2 3 4 5 6 7 8
Prod A, 33 45 37 38 55 30 18 58
Market 1
Prod A, 46 35 41 40 26 48 18 55
Market 2
Prod B, 0 2 3 0 0 1 3 0
Market 1
Product B, 2 4 0 0 3 1 0 0
Market 2
Warehouse
Market 1
© 2003 Simchi-Levi, Kaminsky, Simchi-Levi
Risk Pooling Example
Orders
10 11 12 13 14 15
Demands
© 2003 Simchi-Levi, Kaminsky, Simchi-Levi
To Centralize or not to
Centralize
What is the effect on:
– Safety stock?
– Service level?
– Overhead?
– Lead time?
– Transportation Costs?
Supplier
Warehouse
Retailers
Centralized Decision
to suppliers
Quantitative approaches
Indus
General Overview:
– Judgment methods
– Market research methods
– Time Series methods
– Causal methods
Delphi method
– Inflation rates
– GNP
– Unemployment rates
– Weather
– Sales of other products