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M&DCIndependentDemandOrderingSystems
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M&DCPurchasing&SupplyChain:MaterialManagement

Independent Demand Ordering Systems

IntroductiontoMaterialManagement

Contents

MasterScheduling
MaterialRequirementsPlanning
CapacityManagement

1.

Introduction

ProductionActivityControl

2.

OrderPointSystem

Purchasing

3.

DeterminingSafetyStock

4.

DeterminingServiceLevels

5.

DifferentForecastAndLeadTimeIntervals

6.

DeterminingWhentheOrderPointIsReached

7.

PeriodicReviewSystem

Forecasting
InventoryFundamentals
OrderQuantities

IndependentDemandOrderingSystems8.

DistributionInventory

PhysicalInventoryandWarehouseManagement
PhysicalDistribution

1.Introduction
Theconceptofaneconomicorderquantity,coveredinthelastchapter,addressesthequestionofhow
muchtoorderatonetime.Anotherimportantquestioniswhentoplaceareplacementorder.Ifstock
isnotreorderedsoonenough,therewillbeastockoutandapotentiallossincustomerservice.
However,stockorderedearlierthanneededwillcreateextrainventory.Theproblemthenishowto
balancethecostsocarryingextrainventoryagainstthecostsofastockout.
Nomatterwhattheitemsare,somerulesforreorderingareneededandcanassimpleasorderwhen
needed,ordereverymonth,ororderwhenstockfallstoapredeterminedlevel.Wealluserulesof
somesortinourownlives,andtheyvarydependingonthesignificanceoftheitem.Ahomemaker
usessomeintuitiverulestmakeuptheweeklyshoppinglist.Orderenoughmeatforaweek,ordersalt
whenthboxisempty,ordervanillaextractifitwillbeneededoverthenextweek,andsoon.
Inindustrytherearemanyinventoriesthatinvolvealargeinvestmentandwhenstockoutcostsare
high.Controllingtheseinventoriesrequireseffectivereordersystems.Threebasicsystemsareused
todeterminewhentoorder:
Orderpointsystem.
Periodicreviewsystem.
Materialrequirementsplanning.
Thefirsttwoareforindependentdemanditemsthelastisfordependentdemanditems.

2.OrderPointSystem
Whenthequantityofanitemonhandininventoryfallstoapredeterminedlevel,calledanorder
point,anorderisplaced.Thequantityorderedisusuallyrecalculatedandbasedoneconomicorder
quantityconcepts.
Usingthissystem,anordermustbeplacedwhenthereisenoughstockonhandtosatisfydemand
fromthetimetheorderisplaceduntilthenewstockarrives(calledtheleadtime).Supposethatfora
particularitemtheaveragedemandis100unitsaweekandtheleadtimeisfourweeks.Ifanorderis
placedwhenthereare400unitsonhand,ontheaveragetherewillbeenoughstockonhandtolast
untilthenewstockarrives.However,demandduringanyoneleadtimeperiodprobablyvariesfromthe
averagesometimesmoreandsometimeslessthanthe400.Statistically,halfthetimethedemandis
greaterthanaverage,andthereisastockouthalfthetimethedemandislessthanaverage,andthere
isextrastock.Ifitisnecessarytoprovidesomeprotectionagainstastockout,safetystockcanbe
added.Theitemisorderedwhenthequantityonhandfallstoalevelequaltothedemandduringthe
leadtimeplusthesafetystock:
OP=DDLT+SS
where
OP=orderpoint
DDLT=demandduringtheleadtime
SS=stock
Itisimportanttonotethatitisthedemandduringtheleadtimethatisimportant.Theonlytimea
stockoutispossibleisduringtheleadtime.Ifdemandduringtheleadtimeisgreaterthanexpected,
therewillbeastockoutunlesssufficientsafetystockiscarried.

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ExampleProblem
Demandis200unitsaweek,theleadtimeisthreeweeks,andsafetystockis300
unitsCalculatetheorderpoint.

Answer
OP=DDLT+SS
=200x3+300=900units

Figure11.1Quantityonhandversustime:independentdemanditem.
Figure11.1showstherelationshipbetweensafetystock,leadtime,orderquan

tity,andorderpoint.Withtheorderpointsystem:
Orderquantitiesareusuallyfixed.
Theorderpointisdeterminedbytheaveragedemandduringtheleadtime.Ifthe
averagedemandortheleadtimechangesandthereisnocorrespondingchangeinthe
orderpoint,effectivelytherehasbeenachangeinsafetystock.
Theintervalsbetweenreplenishmentarenotconstantbutvarydependingontheactual
demandduringthereordercycle.
orderquantityQ
Averageinventory=+safetystock=
+SS
22

ExampleProblem
Orderquantityis1000unitsandsafetystockis300units.Whatistheaverageannual
inventory?

Answer
Averageinventory=

1000
=+300
2
=800units
Determiningtheorderpointdependsonthedemandduringtheleadtimeandthesafety
stockrequired.
MethodsofestimatingthedemandduringtheleadtimewerediscussedinChapter8.
Wenowlookatthefactorstoconsiderwhendeterminingsafetystock.

3.DeterminingSafetyStock
Safetystockisintendedtoprotectagainstuncertaintyinsupplyanddemand.Uncertaintymayoccur
intwoways:quantityuncertaintyandtiminguncertainty.Quantityuncertaintyoccurswhentheamount
ofsupplyordemandvariesforexample,ifthedemandisgreaterorlessthanexpectedinagiven
period.Timinguncertaintyoccurswhenthetimeofreceiptofsupplyordemanddiffersfromthat
expected.Acustomerorasuppliermaychangeadeliverydate,forinstance.
Therearetwowaystoprotectagainstuncertainty:carryextrastock,calledsafetystock,ororder
early,calledsafetyleadtime.Safetystockisacalculatedextraamountofstockcarriedandis
generallyusedtoprotectagainstquantityuncertainty.Safetyleadtimeisusedtoprotectagainst
timinguncertaintybyplanningorderreleasesandorderreceiptsearlierthanrequired.Safetystockand
safetyleadtimebothresultinextrainventory,butthemethodsofcalculationaredifferent.

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Safetystockisthemostcommonwayofbufferingagainstuncertaintyandistheonedescribedinthis
text.Thesafetystockrequireddependsonthefollowing:
Variabilityofdemandduringtheleadtime.
Frequencyofreorder.
Serviceleveldesired.
Lengthoftheleadtime.Thelongertheleadtime,themoresafetystockhastobecarriedto
provideaspecifiedservicelevel.Thisisonereasonitisimportanttoreduceleadtimesas
muchaspossible.

VariationinDemandDuringLeadTime
Chapter8discussedforecasterrorandsaidthatactualdemandvariesfromforecast
fortworeasons:biaserrorinforecastingtheaveragedemand,andrandomvariationsin
demandabouttheaverage.Itisthelatterwithwhichweareconcernedindetermining
safetystock.
Supposetwoitems,AandB,haveatenweeksaleshistory,asshowninFigure11.2.
Averagedemandovertheleadtimeofoneweekis1000perweekforbothitems.
However,theweeklydemandforAhasarangefrom700to1400unitsaweekandthat
forBisfrom200to1600unitsperweek.ThedemandforBismoreerraticthanthatfor
A.Iftheorderpointis1200unitsforbothitems,therewillbeonestockoutforAand
fourforB.Ifthesameservicelevelistobeprovided(thesamechanceofstockoutfor
allitems),somemethodofestimatingtherandomnessofitemdemandisneeded

VariationinDemandAbouttheAverage
Supposeoverthepast100weeksahistoryofweeklydemandforaparticulariterr
showsanaveragedemandof1000units.Asexpected,mostofthedemandsare
around
Week

ItemA

ItemB

1200

400

1000

600

800

1600

900

1300

1400

200

1100

1100

1100

1500

700

800

1000

1400

10
TotalAverage

800

1100

10,000

10,000

1000

1000

Figure11.2Actualdemandfortwoitems.
1000asmallernumberwouldbefartherawayfromtheaverageandstillfewerwould
befarthestaway.Iftheweeklydemandsareclassifiedintogroupsorrangesaboutthe
average,apictureofthedistributionofdemandabouttheaverageappears.Suppose
thedemandisdistributedasfollows:
WeeklyDemand

Numberof
Weeks

725774
775824
825874
875924
925974
9751024
10251074
10751124
11251174
11751224
12251274

2
3
7
12
17
20
17
12
7
3
2

ThesedataareplottedtogivetheresultsshowninFigure11.3.Thisisahistogram

Normaldistribution
EverythinginlifevariesevenidenticaltwinsinsomerespectsThe
patternofdemanddistributionabouttheaveragewilldifferfordifferent
product~andmarkets.Somemethodisneededtodescribethe
distributionitsshape,center,amspread.
TheshapeofthehistograminFigure11.3indicatesthatalthough
thereisvariationinthedistribution,itfollowsadefinitepattern,as
shownbythesmoothcurve
Suchanaturalpatternshowspredictability.Aslongasthedemand

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conditionsremainthesame,wecanexpectthepatterntoremainvery
muchthesame.Ifthedemandi~erratic,soisthedemandpattern,
makingitdifficulttopredictwithanyaccuracyFortunately,most
demandpatternsarestableandpredictable.
Themostcommonpredictablepatternissimilartotheone
outlinedbythehistograminFigure11.3andiscalledanormal
curve,orbellcurve,becauseitsshaperesemblesabell.The
shapeofaperfectlynormaldistributionisshowninFigure11.4.
Thenormaldistributionhasmostofthevaluesclusteredneara
centralpointwithprogressivelyfewerresultsoccurringawayfromthe
center.Itissymmetricalaboutthiscentralpointinthatitspreadsout
evenlyonbothsides.

Figure11.3Histogramofactualdemand.

Figure11.4Normaldistribution.

Thenormalcurveisdescribedbytwocharacteristics.Onerelatestoits
centraltendency,oraverage,andtheothertothevariation,or
dispersion,oftheactualvaluesabouttheaverage.

Averageormean
Theaverageormeanvalueisatthehighpointofthecurve.Itisthe
centraltendencyofthedistribution.Thesymbolforthemeanis
(pronouncedxbar).Itiscalculatedbyaddingthedataanddividing
bythetotalnumberofdata.Inmathematicalterms,itcanbewritten
as:

X
X=.
n

Wherexstandsfortheindividualdata(inthiscase,theindividual
demands,(capitalGreeklettersigma)isthesummationsign,andnis
thenumberofdata(demands).

ExampleProblem
Giventhefollowingactualdemandsforatenweekperiod,Calculatetheaverageof
thedistribution.

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Period

ActualDemand

1200

1000

800

900

1400

1100

1100

700

1000

10

800

Total

10000

Answer
X1000
X===
1000units
n10

Dispersion
Thevariation,ordispersion,ofactualdemandsabouttheaverage
referstohowcloselytheindividualvaluesclusteraroundthemeanor
average.Itcanbemeasuredinseveralways:
Asarangeofthemaximumminustheminimumvalue.
Asthemeanabsolutedeviation(MAD),whichisameasureofthe
averageforecasterror.
Asastandarddeviation.

StandardDeviation(Sigma)
Thestandarddeviationisastatisticalvaluethatmeasureshowcloselytheindividual
valuesclusterabouttheaverage.ItisrepresentedbytheGreeklettersigma(a).The
standarddeviationiscalculatedasfollows:

a.

Calculatethedeviationforeachperiodbysubtractingtheactualdemandfrom
theforecastdemand.

b.
c.

Squareeachdeviation.

d.

Dividethevalueinstep3bythenumberofperiodstodeterminetheaverageof
thesquareddeviations.

e.

Calculatethesquarerootofthevaluecalculatedinstep4.Thisisthestandard
deviation.

Addthesquaresofthedeviations.

Itisimportanttonotethatthedeviationsindemandareforthesametimeintervals
astheleadtime.Iftheleadtimeisoneweek,thenthevariationindemandovera
oneweekperiodisneededtodeterminethesafetystock.

ExampleProblem
Giventhedatafromthepreviousexampleproblem,calculatethestandarddeviation
(sigma)

Answer
Period

1
2
3
4
5
6
7
8
9
10
Total

Forecast
demand

Actual
demand

1000
1000
1000
1000
1000
1000
1000
1000
1000
1000
10000

1200
1000
800
900
1400
1100
1100
700
1000
800
10000

Deviation

200
0
200
100
400
100
100
300
0
200
0

Deviation
squared

40000
0
40000
10000
160000
10000
10000
90000
0
40000
400000

Averageofthesquaresofthedeviation=400,0001040,000
Fromstatistics,wecandeterminethat:
Theactualdemandwillbewithin1sigmaoftheforecastaverageapproximately68%ofthe

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time.
Theactualdemandwillbewithin2sigmaoftheforecastaverageapproximately98%ofthe
time.
Theactualdemandwillbewithin3sigmaoftheforecastaverageapproximately99.88%of
thetime.

DeterminingtheSafetyStockandOrderPoint
Nowthatwehavecalculatedthestandarddeviation,wemustdecidehowmuchsafety
stockisneeded.
Onepropertyofthenormalcurveisthatitissymmetricalabouttheaverage.This
meansthathalfthetimetheactualdemandislessthantheaverageandhalfthetime
itisgreater.Safetystocksareneededtocoveronlythoseperiodsinwhichthe
demandduringtheleadtimeisgreaterthantheaverage.Thus,aservicelevelof50%
canbeattainedwithnosafetystock.Ifahigherservicelevelisneeded,safetystock
mustbeprovidedtoprotectagainstthosetimeswhentheactualdemandisgreater
thantheaverage.
Asstatedearlier,weknowfromstatisticsthattheerroriswithin1sigmaofthe
forecastabout68%ofthetime(34%ofthetimelessand34%ofthetimegreaterthan
theforecast).
Supposethestandarddeviationofdemandduringtheleadtimeis100unitsandthis
amountiscarriedassafetystock.Thismuchsafetystockprovidesprotectionagainst
stockoutforthe34%ofthetimethatactualdemandisgreaterthanexpected.Intotal,
thereisenoughsafetystocktoprovideprotectionforthe84%ofthetime(50%+34%
=84%)thatastockoutispossible.
Theservicelevelisastatementofthepercentageoftimethereisnostockout.But
whatexactlyismeantbysupplyingthecustomer84%ofthetime?Itmeansbeingable
tosupplywhenastockoutispossible,andastockoutispossibleonlyatthetimean
orderistobeplaced.Ifweorder100timesayear,thereare100chancesofa
stockout.Withsafetystockequivalenttoonemeanabsolutedeviation,ontheaverage
wewouldexpectnostockoutsabout84ofthe100times.

ExampleProblem
Usingthefiguresinthelastexampleprobleminwhichthesigmawascalculateda~
200units,

a.

Calculatethesafetystockandtheorderpointforan84%servicelevel.

b.

Ifasafetystockequaltotwostandarddeviationsiscarried,calculatethesafety
stockandtheorderpoint.

Answer
a.

Safetystock=1sigma
=1x200
=200units
Orderpoint=DDLT+SS
=1000+200=1200units
whereDDLTandSSareasdefinedpreviously.Withthisorderpointandlevelofsafety
stock,ontheaveragetherearenostockouts84%ofthetimewhenastockoutis
possible.

a.

SS=2x200
=400units
OP=DDLT+SS
=1000+400
=1400units

Safetyfactor
Theservicelevelisdirectlyrelatedtothenumberofstandard
deviationsprovidedassafetystockandisusuallycalledthesafety
factor.
Figure11.5showssafetyfactorsforvariousservicelevels.Notethat
theservicelevelisthepercentageofordercycleswithoutastockout

ExampleProblem
Ifthestandarddeviationis200units,whatsafetystockshouldbecarriedtoprovidea
servicelevelof90%?Iftheexpecteddemandduringtheleadtimeis1500units,what
istheorderpoint?

Answer

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FromFigure11.5,thesafetyfactorforaservicelevelof90%is1.28.Therefore,
Safetystock=sigmaxsafetyfactor
=200x1.28
=256units
Orderpoint=DDLT+SS
=1500+256
=1756units

4.DeterminingServiceLevels
Theoretically,wewanttocarryenoughsafetystockonhandsothecostofcarryingtheextrainventory
plusthecostofstockoutsisaminimum.Stockoutscostmoneyforthefollowingreasons:
Backordercosts.
Lostsales.
Lostcustomers.
ServiceLevel(%)

SafetyFactor

50

75

0.67

80

0.84

85

1.04

90

1.28

94

1.56

95

1.65

96

1.75

97

1.88

98

2.05

99

2.33

99.86

99.99

Figure11.5Tableofsafetyfactors.
Thecostofastockoutvariesdependingontheitem,themarketserved,thecustomer,and
competition.Insomemarkets,customerserviceisamajorcompetitivetool,andastockoutcanbe
veryexpensive.Inothers,itmaynotbeamajorconsideration.Stockoutcostsaredifficultto
establish.Usuallythedecisionaboutwhattheservicelevelshouldheisaseniormanagement
decisionandispartofthecompanycorporateandmarketingstrategy.Assuch,itisbeyondthescope
ofthistext.
Theonlytimeitispossibleforastockouttooccuriswhenstockisrunninglowandthishappens
everytimeanorderistobeplaced.Therefore,thechancesofstockoutaredirectlyproportionaltothe
frequencyofreorder.Themoreoftenstockisreordered,themoreoftenthereisachanceofa
stockout.Figure11.6showstheeffectoftheorderquantityonthenumberofexposuresperyear.Note
alsothatwhentheorderquantityisincreased,exposuretostockoutdecreases.Thesafetystock
neededdecreases,butbecauseofthelargerorderquantity,theaverageinventorincreases.
Itistheresponsibilityofmanagementtodeterminethenumberofstockoutperyearthataretolerable.
Thentheservicelevel,safetystock,andorderpointcanbcalculated.

Figure11.6Exposurestostockout.

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M&DCIndependentDemandOrderingSystems

ExampleProblem
Supposemanagementstatedthatitcouldtolerateonlyonestockoutperyearfora
specificitem.
Forthisparticularitem,theannualdemandis52,000units,itisorderedinquantities
of2600,andthestandarddeviationofdemandduringtheleadtimeis100units.The
leadtimeisoneweek.Calculate:

a.

Numberofordersperyear.

b.

Servicelevel.

c.

Safetystock.

d.

Orderpoint.

Answer
annualdemand
a. Numberofordersperyear=
orderquantity
52.000
==20times
peryear
2600

b. Sinceonestockoutperyearistolerable,theremust
benostockouts19(201)timesperyear.
201
Servicelevel=95%
20

c. FromFigure11.5
Safetyfactor=1.65
Safetystock=safetyfactorx
sigma
=1.65x100165units

(52.000)
d. d.Demandduringleadtime=(1week)=
1000units
52
Orderpoint=demandduringlead
time+SS
=1000+165=1165
units

5.DifferentForecastAndLeadTimeIntervals
Usually,therearemanyitemsinaninventory,eachwithdifferentleadtimes.Recordsofactual
demandandforecastsarenormallymadeonaweeklyormonthlybasisforallitemsregardlessofwhat
theindividualleadtimesare.Itisalmostimpossibletomeasurethevariationindemandaboutthe
averageforeachoftheleadtimes.Somemethodofadjustingstandarddeviationforthedifferenttime
intervalsisneeded.
Iftheleadtimeiszero,thestandarddeviationofdemandiszero.Astheleadtimeincreases,the
standarddeviationincreases.However,itwillnotincreaseindirectproportiontotheincreaseintime.
Forexample,ifthestandarddeviationis100foraleadtimeofoneweek,thenforaleadtimeoffour
weeksitwillnotbe400,sinceitisveryunlikelythatthedeviationwouldbehighforfourweeksina
row.Asthetimeintervalincreases,thereisasmoothingeffect,andthelongerthetimeinterval,the
moresmoothingtakesplace.
Thefollowingadjustmentcanbemadetothestandarddeviationorthesafetystocktocompensatefor
differencesbetweenleadtimeinterval(LTI)andforecastinterval(Fl).Whilenotexact,theformula
givesagoodapproximation:

ExampleProblem
Theforecastintervalisfourweeks,theleadtimeintervalistwoweeks,andsigmafor
theforecastintervalis150units.Calculatethestandarddeviationfortheleadtime
interval.

Answer

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TheprecedingrelationshipisalsousefulwherethereisachangeintheLTI.Nowitis
probablymoreconvenienttoworkdirectlywiththesafetystockratherthanthemean
absolutedeviation.Therelationshipisasfollows:

ExampleProblem
Thesafetystockforanitemis150units,andtheleadtimeistwoweeks.Ifthelead
timechangestothreeweeks,calculatethenewsafetystock.

Answer

=150x1.22183units

6.DeterminingWhentheOrderPointIsReached
Theremustbesomemethodtoshowwhenthequantityofanitemonhandhasreachedtheorder
point.Inpractice,therearemanysystems,buttheyallareinclinedtobevariationsorextensionsof
twobasicsystems:thetwobinsystemandtheperpetualinventorysystem.

TwoBinSystem
Aquantityofanitemequaltotheorderpointquantityissetaside(frequentlyina
separateorsecondbin)andnottoucheduntilallthemainstockisusedup.Whenthis
stockneedstobeused,theproductioncontrolorpurchasingdepartmentisnotified
andareplenishmentorderisplaced.
Therearevariationsonthissystem,suchastheredtagsystem,whereatagis
placedinthestockatapointequaltotheorderpoint.Bookstoresfrequentlyusethis
system.Atagorcardisplacedinabookthatisinastackinapositionequivalentto
theorderpoint.Whenacustomertakesthatbooktothecheckout,thestoreis
effectivelynotifiedthatitistimetoreorderthattitle.
ThetwobinsystemisasimplewayofkeepingcontrolofCitems.Becausetheyare
oflowvalue,itisbesttospendtheminimumamountoftimeandmoneycontrolling
them.However,theydoneedtobemanaged,andsomeoneshouldbeassignedto
ensurethatwhenthereservestockisreachedanordermustbeplaced.Whenitisout
ofstock,aCitembecomesanAitem.

PerpetualInventoryRecordSystem
Aperpetualinventoryrecordisacontinualaccountofinventorytransactionsas
theyoccur.Atanyinstant,itholdsanuptodaterecordoftransactions.Ata
minimum,itcontainsthebalanceonhand,butitmayalsocontainthequantityon
orderbutnotreceived,thequantityallocatedbutnotissued,andtheavailable
balance.Theaccuracyoftherecorddependsuponthespeedwithwhichtransactions
arerecordedandtheaccuracyoftheinput.Becausemanualsystemsrelyonthe
inputofhumans,theyaremorelikelytohaveslowresponseandinaccuracies.
Computerbasedsystemshaveahighertransactionspeedandreducethepossibility
ofhuman
error
426254SCREW500

ORDERORDERQUANTITY
POINT100

DATE ORDERED RECEIVED ISSUED ON ALLOCATED AVAILABLE

HAND

500

500

500

400

100

500

500

400

100

100

500

600

600

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Figure11.7Perpetualinventoryrecord.
Aninventoryrecordcontainsvariableandpermanentinformation.Figure11.7shows
anexampleofaperpetualinventoryrecord.
PermanentinformationisshownatthetopofFigure11.7.Althoughnotabsolutely
permanent,thisinformationdoesnotchangefrequently.Anyalterationisusuallythe
resultofanengineeringchange,manufacturingprocesschange,orinventory
managementchange.Itincludesdatasuchasthefollowing:
Partnumber,name,anddescription.
Storagelocation.
Orderpoint.
Orderquantity.
Leadtime.
Safetystock.
Suppliers.
Variableinformationisinformationthatchangeswitheachtransactionandincludes
thefollowing:
Quantitiesordered:dates,ordernumbers,andquantities.
Quantitiesreceived:dates,ordernumbers,andquantities.
Quantitiesissued:dates,ordernumbers,andquantities.
Balanceonhand.
Allocated:dates,ordernumbers,andquantities.
Availablebalance.
Theinformationdependsontheneedsofthecompanyandtheparticularcir
constancies.

7.PeriodicReviewSystem
Intheorderpointsystem,anorderisplacedwhenthequantityonhandfallstoapredeterminedlevel
calledtheorderpoint.Thequantityorderedisusuallypredeterminedonsomebasissuchasthe
economicorderquantity.Theintervalbetweenordersvariesdependingonthedemandduringany
particularcycle.
Usingtheperiodicreviewsystem,thequantityonhandofaparticularitemisdeterminedatspecified,
fixedtimeintervals,andanorderisplaced.Figure11.8illustratesthissystem.
Figure11.8showsthatthereviewintervals(t1,t2,andt3)areequalandthatQ1,Q2andQ3arenot
necessarilythesame.Thusthereviewperiodisfixed,andtheorderquantityisallowedtovary.The
quantityonhandplusthequantityorderedmustbe
Sufficienttolastuntilthenextshipmentisreceived.Thatis,thequantityonhandplusthequantity
orderedmustequalthesumofthedemandduringtheleadtimeplusthedemandduringthereview
periodplusthesafetystock.

TargetLevelorMaximumLevelInventory
Thequantityequaltothedemandduringtheleadtimeplusthedemandduringthe
reviewperiodplussafetystockiscalledthetargetlevelormaximumlevel
inventory:
T=D(R+L)+SS
where
T=target(maximum)inventorylevel
D=demandperunitoftime
L=leadtimeduration
R=reviewperiodduration
SS=safetystock

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Figure11.8Periodicreviewsystem:unitsinstockversustime.
Theorderquantityisequaltothemaximuminventorylevelminusthequantityonhandatthe
reviewperiod:
Q=TI
where
Q=orderquantity
I=inventoryonhand
Theperiodicreviewsystemisusefulforthefollowing:
Wheretherearemanysmallissuesfrominventory,andpostingtransactionsto
inventoryrecordsareveryexpensive.Supermarketsandretailersareinthiscategory.
Whereorderingcostsaresmall.Thisoccurswhenmanydifferentitemsareor
dered
fromonesource.Aregionaldistributioncentermayordermostorallolitsstockfrom
acentralwarehouse.
Wheremanyitemsareorderedtogethertomakeupaproductionrunorfillatruckload.
Agoodexampleofthisisaregionaldistributioncenterthatordersatruckloadoncea
weekfromacentralwarehouse.

ExampleProblem
Ahardwarecompanystocksnutsandboltsandordersthemfromalocalsupplieronc
everytwoweeks(tenworkingdays).Leadtimeistwodays.Thecompanyhasdeter
minedthattheaveragedemandfor1/2inchboltsis150perweek(fiveworkingdays)
anditwantstokeepasafetystockofthreedayssupplyonhand.Anorderistob
placedthisweek,andstockonhandis130bolts.

a.

Whatisthetargetlevel?

b.

Howmany1/2inchboltsshouldbeorderedthistime?

Answer
Let
D=demandperunitoftime=1505=30perworkingday
L=leadtimeduration=2days
R=reviewperiodduration=10days
SS=safetystock=3dayssupply=90units
I=inventoryonhand=130units
Then
TargetlevelT=D(R+L)+SS
=30(10+2)+90
=450units
OrderquantityQ=TI
=450130=320units

8.DistributionInventory
Distributioninventoryincludesallthefinishedgoodsheldanywhereinthedistributionsystem.The
purposeofholdinginventoryindistributioncentersistoimprovecustomerservicebylocatingstock
nearthecustomerandtoreducetransportationcostsbyallowingthemanufacturertoshipfullloads
ratherthanpartialloadsoverlongdistances.ThiswillbestudiedinChapter13.
Theobjectivesofdistributioninventorymanagementaretoprovidetherequiredlevelofcustomer
service,tominimizethecostsoftransportationandhandling,andtobeabletointeractwiththefactory
tominimizeschedulingproblems.
Distributionsystemsvaryconsiderably,butingeneraltheyhaveacentralsupplyfacilitythatis
supportedbyafactory,anumberofdistributioncenters,and,finally,customers.Figure11.9isa
schematicofsuchasystem.Thecustomersmaybethefinalconsumerorsomeintermediaryinthe
distributionchain.
Unlessafirmdeliversdirectlyfromfactorytocustomer,demandonthefactoryiscreatedbycentral
supply.Inturn,demandoncentralsupplyiscreatedbythedistributioncenters.Thiscanhavesevere
repercussionsonthepatternofdemandoncentralsupplyandthefactory.Althoughthedemandfrom
customersmayberelativelyuniform,thedemandoncentralsupplyisnot,becauseitisdependenton
whenthedistributioncentersplacereplenishmentorders.Inturn,thedemandonthefactorydepends
onwhencentralsupplyplacesorders.Figure11.10showstheprocessschematically.
Thedistributionsystemisthefactoryscustomer,andthewaythedistributionsysteminterfaceswith
thefactoryhasasignificanteffectontheefficiencyoffactoryoperations.
Distributioninventorymanagementsystemscanbeclassifiedintodecentralized,centralizedand
distributionrequirementsplanning.

DecentralizedSystem
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Inadecentralizedsystem,eachdistributioncenterfirstdetermineswhatitneedsand
when,andthenplacesordersoncentralsupply.Eachcenterordersonitsownwithout
regardfortheneedsofothercenters,availableinventoryatcentralsupply,orthe
productionscheduleofthefactory.
Theadvantageofthedecentralizedsystemisthateachcentercanoperateonitsown
andthusreducecommunicationandcoordinationexpense.Thedisadvantageisthe
lackofcoordinationandtheeffectthismayhaveoninventories,customerservice,
andfactoryschedules.Becauseofthesedeficiencies,manydistributionsystems
havemovedtowardmorecentralcontrol.
Anumberoforderingsystemscanbeused,includingtheorderpointandperiodic
reviewsystems.Thedecentralizedsystemissometimescalledthepullsystem
becauseordersareplacedoncentralsupplyandpulledthroughthesystem.

Figure11.9Schematicofadistributionsystem.

Figure11.10Distributioninventory.

CentralizedSystem
Inacentralizedsystem,allforecastingandorderdecisionsaremadecentrally.
Stockispushedoutintothesystemfromcentralsupply.Distributioncentershave
nosayaboutwhattheyreceive.
Differentorderingsystemscanbeused,butgenerallyanattemptismadetoreplace
thestockthathasbeensoldandtoprovideforspecialsituationssuchasseasonality
orsalespromotions.Thesesystemsattempttobalancetheavailableinventorywith
theneedsofeachdistributioncenter.

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Theadvantageofthesesystemsisthecoordinationbetweenfactory,centralsupply,
anddistributioncenterneeds.Thedisadvantageistheinabilitytoreacttolocal
demand,thusloweringthelevelofservice.

DistributionRequirementsPlanning
Distributionrequirementsplanningareasystemthatforecastswhenthevarious
demandswillbemadebythesystemoncentralsupply.Thisgivescentralsupplyand
thefactorytheopportunitytoplanforthegoodsthatwillactuallybeneededandwhen.
itisablebothtorespondtocustomerdemandandcoordinateplanningandcontrol.
Thesystemtranslatesthelogicofmaterialrequirementsplanningtothedistribution
system.Plannedorderreleasesfromthevariousdistributioncentersbecametheinput
tothematerialplanofcentralsupply.Theplannedorderreleasesfromcentralsupply
becometheforecastofdemandforthefactorymasterproductionscheduleFigure
11.11showsthesystemschematically.Therecordsshownareallforthesamepart
number.

Figure11.11Distributionrequirementsplanning.

ExampleProblem
Acompanymakinglawnmowershasacentralsupplyattachedtotheirfactoryandtwo
distributioncenters.DistributioncenterAforecastsdemandat25,30,55,50,and30
unitsoverthenextfiveweeksandhas100lawnmowersintransitthataredueinweek
2.Thetransittimeistwoweeks,theorderquantityis100units,andthereare50units
onhand.DistributioncenterBforecastsdemandat95,85,100,70,and50overthe
nextfiveweeks.Transittimeisoneweek,theorderquantityis200units,andthereare
100unitsonhand.Calculatethegrossrequirements,projectedavailable,andplanned
orderreleasesforthetwodistributioncenters,andthegrossrequirements,projected
available,andplannedorderreleasesforthecentralwarehouse.

Answer
DistributionCenterA
TransitTime:2weeks
OrderQuantity:100units
Week

Gross
Requirements

25

InTransit

25

ProjectedAvailable
50
PlannedOrder
Release

30

55

50

30

100

95

40

90

60

100

DistributionCenterB
TransitTime:Iweek
OrderQuantity:200units
Week

Gross
Requirements

95

85

100

70

30

120

20

150

100

InTransit
ProjectedAvailable

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100
PlannedOrder
Release

200

200

CentralSupply
LeadTime:2weeks
OrderQuantity:500units
Week
Gross
Requirements
InTransit

200

100

200

Projected
Available100

200

100

400

PlannedOrder
Release

500

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