Module 2

9/24/2012
Demand Planning
&
Forecasting
Module 2, Section 1
Broad outline
Overview on demand planning and forecasting

Characteristics of forecasts
Components of a forecast
Forecasting methods: Qualitative
(i) Jury of executive opinion method
(ii) Delphi method
(iii) Market research
Forecasting methods: Quantitative

Estimating forecast errors
9/24/2012
Broad outline
Time-series forecasting models:
(i) Moving average
(ii) Weighted moving average
(iii) Exponential smoothing
(iv) Nave forecast
(v) Trend-corrected exponential smoothing
(vi) Seasonality-corrected exponential smoothing
(vii) Trend and seasonality corrected exponential
smoothing
Selection of a particular forecasting tool
Demand planning and forecasting: An

overview
The very first step in determining the long-term
capacity needs, yearly business plan, and supply
chain activities of an organization.
Examples:
(i) Based on forecast demand of automobiles, capacity
requirement of automobile manufacturing plant, investment
requirement and manpower requirement of varied level of skills
are computed.
(ii) The same approach applies to FMCG and consumer durables
also for finding out capacity requirement and manpower
requirement .
9/24/2012
Demand planning and forecasting: An

overview
(iii) The capacity requirement of hotels, airlines and other service
organizations are also determined based on forecast demand.
Different organizations utilize different types of

forecasting techniques depending on the problems
faced by them.
Forecasted values can never be perfect because
forecasting itself is fraught with errors.
Demand forecasting tries to capture the estimated
demand of a product or service for a future period.
Characteristics of forecasts
Forecasts are almost always wrong.
Long-term forecasts are usually less accurate than
short-term forecasts.
Aggregate forecasts are usually more accurate than
disaggregate forecasts.
In general, the farther up the supply chain a
company is, the greater is the distortion of
information it receives.
9/24/2012
Components of forecast
Consists of two components: (a) Systematic
component & (b) random component.
Systematic component consists of
(i) Level (current deseasonalized demand),
(ii) Trend (growth or decline in demand),
(iii) Seasonality (predictable seasonal fluctuation in demand)
Random component is that part of the forecast that

cannot be explained by the historical demand
patterns.
Systematic components of forecast
(Source: Shah, 2009, Supply Chain Management, Pearson Education)
9/24/2012

(A) Jury of executive opinion method:
Involves securing opinions from a group of experts on
expected future sales and combining them into the estimate
of future sales.
Quick and relatively inexpensive method.
Applicable for finding out the forecast demand of both new as
well as existing products.
Based on subjective judgment of experts and hence suffers
from the biases of experts.

(B) Delphi method:
Involves eliciting responses from a panel of experts and
proceeds through a series of rounds.
The first round of Delphi method is, in general, unstructured
and exploratory in nature.
Later rounds are structured and attempts to achieve a
reasonable degree of consensus amongst the experts without
disclosing the identity of the experts.
Useful when a new product is launched in the market.
Relevant when major technological changes are expected in
the market.
It is a very time-consuming method.
9/24/2012

(C) Market survey:
Involves eliciting opinions from the potential customers

through market survey for the purpose of estimating the
market size.
Market survey may be carried out through focus group
interview, telephonic interview, direct interview or simple
questionnaire survey.
Relevant when a new product is at the conception stage and
firms attempt to know the purchase preferences of potential
customers.
Relevant when a firm does some innovations in its existing
products.
Relatively expensive method of forecasting.

(A) Time series:
Consists of observations arranged in a chronological order.
Chronology of observations and the respective values are
utilized to forecast the demand.
Based on the assumption that past demand history is a good
indicator of future demand.
Most appropriate when the basic demand pattern does not
vary significantly from one year to the next.
Tries to predict the systematic component of demand.
9/24/2012

(B) Causal methods:
Based on the assumption that demand forecast is highly
correlated with certain factors prevailing in the
environment, e.g. GDP growth rate, interest rate,
promotional efforts by a firm etc.
There could be single or multiple causal variables which
might influence the demand.
Suitable for medium to long term forecasting.
Tries to predict the systematic component of demand.
Estimating forecast error

The forecast error for period t is the difference between the
actual demand and the forecast for that time period, i.e.
Forecast error (Et) = Actual demand (Dt) Forecast (Ft)
Four measures of forecast errors are mostly used in practice.
(i) Mean error (ME):
(ii) Mean absolute deviation (MAD):
(iii) Mean squared error (MSE):
(iv) Mean absolute percentage error (MAPE):
9/24/2012
Estimating forecast error

ME simply calculates average error over n time periods.
ME fails to capture the magnitude of error because positive
and negative error may cancel out each other.
Closer to zero value of ME indicates that the forecasting
method is almost unbiased.
MAD captures the magnitude of error by considering the
absolute difference between actual and forecast values.
MSE method also captures the magnitude of forecast error
and attaches higher penalty to higher value of forecast error.
MAPE considers the absolute deviations between actual
demand and its forecast as a percentage of actual demand
and finds out its mean over n time periods.
Time Series Forecasting Methods

Systematic component of demand is computed using the
following forms of the equations:
Multiplicative: Systematic component = level X trend X
seasonal factor
Additive: Systematic component = level + trend + seasonal
factor
Mixed: Systematic component = (level + trend) X seasonal
factor
Mixed method seems to produce better forecasts than the other
two.
9/24/2012

Static method:
Based on the assumption that the estimates of level, trend and

seasonality within the systematic component do not vary as
new demand is observed.
Uses the same parameters for all future forecasts.
The forecast for period t+l in period t is as follows:
L = estimate of level, i.e. the deseasonalized demand during period
t=0
T = estimate of trend
St+l = estimate of seasonal factor for period t+l

Adaptive method:
Updates the estimates of level, trend and seasonality after
each demand observation.
The forecast for period t+l in period t is given as:
Lt = estimate of level at the end of period t
Tt = estimate of trend at the end of period t
St+l = estimate of seasonal factor for period t+l
9/24/2012

(i) Moving Average (MA) method:
Used when the systematic component of demand consists of
only level and does not have trend or seasonality.
The level in period t (Lt) is estimated as the average demand
over the most recent n periods.
Where Dt indicates the actual demand observed in period t
Thus forecast for period (t+1) is the same as the level in
period t, i.e.
Further forecast for future period n is also same as the level in
period t, i.e.

Attaches equal weight to all the periods of past demand.
Accounts for the effects of random variations by averaging out
the demand data of the most recent periods.
With more number of periods, MA method becomes less
sensitive to the actual changes in the data.
Quite popular in practice and finds applications when demand
of a product does not show much variation from period to
period.
10
9/24/2012

Example: Refer to example 1 of the main text.
Forecasting of mobile phone through 3-month moving average
Month
Demand (D)
Level (L)
Forecast (F)
Error
Abs error
Squared error
Jan, 10
200
Feb
190
Mar
180
190
April
210
193.33
190
20
20
400
May
195
195
193.33
1.67
1.67
2.78
June
175
193.33
195
-20
20
400
July
170
180
193.33
-23.33
23.33
544.44
August
172
172.33
180
-8
64
September
178
173.33
172.33
5.67
5.67
32.11
October
230
193.33
173.33
56.67
56.67
3211.11
November
225
211
193.33
31.67
31.67
1002.78
December
224
226.33
211
13
13
169
Jan, 11
226.33

Mean error
8.59
MAD
20
MSE
647.35
MAPE
9.76
The forecast for the month of January, 2011 is 226.33.
(ii) Weighted MA method:

Tends to put more weight on the most recent data and
relatively less weight to the data of the distant periods.
The level in period t (Lt) is estimated as the weighted average
demand over the most recent n periods, i.e.
Where
Thus forecast for period (t+1) is the same as the level in
period t, i.e.
11
9/24/2012

Example: Refer to example 2 of the main text.
In this problem, the weights 0.25, 0.35 and 0.40 are placed on the demand of
period 1, period 2 and period 3 respectively in all the cases while computing
the forecast demand of the next period.
Forecasting through 3-month weighted moving average
Month
Demand (D)
Level (L)
Forecast (F)
Error
Abs error
Squared error
Jan, 10
200
Feb
190
Mar
180
188.5
April
210
194.5
188.5
21.5
21.5
May
195
196.5
194.5
0.5
0.5
0.25
June
175
190.75
196.5
-21.5
21.5
462.25
July
170
178
190.75
-20.75
20.75
430.5625
August
172
172.05
178
-6
36
September
178
173.9
172.05
5.95
5.95
35.4025
October
230
197.3
173.9
56.1
56.1
3147.21
November
225
215
197.3
27.7
27.7
767.29
December
224
225.85
215
81
Jan, 11
462.25
225.85

Mean error
8.055
MAD
18.777
MSE
602.468
MAPE
9.17
The forecast for the month of January, 2011 is 225.85.
(iii) Simple exponential smoothing:

Forecast demand of the next period is calculated as the weighted
average of the current periods actual demand and forecast demand
through the following formula.
Ft+1: Forecast for time period (t+1)
Ft: Forecast for time period t
Dt: Actual demand for time period t
: Smoothing constant used to weight Dt and Ft (0<=<=1)
12
9/24/2012

Systematic component of demand does not have any
observable trend and seasonality and only contains Level (Lt).
In exponential smoothing, the current forecast for all future
periods is equal to the current estimate of level and is given as
and
The initial estimate of level (L0) is taken to be the average of
all historical data. Given demand data for periods 1 through n,
L0 is expressed as:
Closer the value of is to 1, the greater is the weight put on
the most recent actual demand and closer its value is to 0, the
more emphasis is put on the past forecasts.
Value of chosen through trial and error method

Example: Refer to example 3 of the main text. Value of = 0.2
Forecasting through simple exponential smoothing
Period
Month
Demand (D)
Forecast
Error
Absolute error
Squared error
195.36
1 Jan, 10
200
196.29
195.36
4.63
4.63
2 Feb
190
195.03
196.29
-6.29
6.29
39.57
3 Mar
180
192.03
195.03
-15.03
15.032
225.98
4 April
210
195.62
192.03
17.97
17.97
323.058
5 May
195
195.49
195.62
-0.62
0.62
0.385
6 June
175
191.39
195.49
-20.49
20.49
420.11
7 July
170
187.12
191.39
-21.39
21.39
457.85
8 August
172
184.09
187.12
-15.12
15.11
228.55
9 September
178
182.87
184.09
-6.094
6.094
37.140
10 October
230
192.30
182.87
47.12
47.124
2220.72
11 November
225
198.840
192.30
32.69
32.69
1069.265
12 December
224
203.87
198.84
25.16
25.16
633.010
13
Jan, 11
Mean error
3.545
Level
21.49
203.87
MAD
17.72
MSE
473.09
MAPE
8.80
Forecast demand for the month of January, 2011 is 203.87
13
9/24/2012

(iv) Nave Forecast:
Forecast for the next period is considered equal to the actual
demand of the current period.
Thus current demand is the best estimator of the future
demand, i.e.
Does not incorporate any element of systematic component,
i.e. level, trend or seasonality.
Does not account for the random component into its forecast.
Suitable for those products which exhibit stable demand
pattern, e.g. groceries, staple food items etc.
Forecast demand of mobile phone for the month of January
2011 will be the same as the actual demand observed in
December, 2010.

(v) Trend-corrected exponential smoothing:
Applicable when demand consists of both level and trend in
the systematic component but no seasonality.
In period t, given estimates of Lt and Tt, the forecast for future
periods is expressed as
and
After observing demand for period t, the revised estimates of
level and trend are as follows:
is a smoothing constant for the level (0<=<=1) and is a

smoothing constant for the trend (0<=<=1).
14
9/24/2012

Example: Refer to example 4 of the main text. The value of = 0.2 and = 0.3.
The value of L0 and T0 are 179.95 and 2.43 respectively, which are determined
through running a linear regression between actual demand (Dt) and the periods
(t).
Forecasting through trend-corrected exponential smoothing
Month
Demand (D)
Level (Lt)
Trend (Tt)
179.95
2.43
Forecast
(Ft+1)
Squared error
Jan, 10
200
185.90
3.48
10.60
10.60
Feb
190
189.51
3.52
189.39
-3.03
3.03
9.22
Mar
180
190.43
2.74
193.036
-13.17
13.17
173.47
April
210
196.53
3.75
193.17
9.71
9.71
94.32
May
195
199.23
3.43
200.28
-7.66
7.66
58.74
June
175
197.13
1.77
202.66
-23.90
23.90
571.48
July
170
193.12
0.039
198.90
-23.16
23.16
536.59
August
172
188.93
-1.23
193.16
-15.70
15.70
246.53
Sept
178
185.76
-1.81
187.70
-5.95
5.95
35.39
Oct
230
193.16
0.95
183.95
35.88
35.88
1288.08
Nov
225
200.28
2.80
194.11
21.90
21.90
479.94
Dec
224
207.27
4.058
203.092
12.66
12.66
160.46
Jan, 11
Mean error MAD

-0.15
15.28
Absolute
error
Error
112.54
211.33
MSE
313.9
MAPE
7.794
Forecast for the month of January, 2011 is 211.33.

(vi) Seasonality-corrected exponential smoothing:
Applicable when demand consists of level and seasonality in the
systematic component but no trend.
Systematic component of demand = level X seasonal factor
The seasonal factor is represented by periodicity (p). p is the
number of periods after which the seasonal cycle repeats itself.
The forecast for future period is given by
and
On observing demand for period (t+1), the estimates of level and
seasonal factors are computed as follows:
is a smoothing constant for level (0<=<=1) and is a smoothing

constant for seasonality (0<=<=1).
15
9/24/2012

Steps followed for finding out seasonal factors:
Step 1: Observe the periodicity (p)of demand.
Step 2: Obtain the deseasonalized demand.
Step 3: Find out the seasonal factor (St) of each individual
period by dividing actual demand by the deseasonalized
demand of the corresponding period.
Step 4: Estimate the average value of seasonal factor ( ) by
taking the average of individual seasonal factors (St) of the
same quarters over the seasonal cycles.

Example: Refer to example 5 of the main text. The value of = 0.2 and = 0.4.
The value of initial level (L0) is the average of the actual demand observed in
12 quarters over 3 years. This turns out to be 195.75.
Forecasting through seasonality-corrected exponential smoothing
Period
Demand (Dt)
0
Deseasonalized
demand ( Dt )
Level (Lt)
Seasonality
(St)
Average
seasonality( St )
195.75
200
197.69
190
194.92
180
193.98
194.37
0.926
0.946
210
196.23
191.87
1.0944
1.023
195
196.40
188.75
1.033
0.989
175
191.79
182.75
0.957
1.009
170
189.65
175.87
0.966
0.938
172
184.73
180.62
0.952
1.042
178
183.71
194.37
0.915
0.990
10
230
194.36
207.75
1.107
0.970
11
225
204.30
0.921
12
224
208.34
0.997
13
0.974
1.032
0.982
16
9/24/2012

Period
Forecast (F)
Absolute
error
Error
Squared error
Mean error
4.73
190.745
9.254
9.254
85.646
204.042
-14.042
14.042
197.196
184.465
-4.465
4.465
19.938
198.515
11.484
11.484
131.884
194.153
0.846
0.846
0.717
198.226
-23.226
23.226
539.449
180.089
-10.09
10.09
101.807
197.630
-25.63
25.63
656.911
183.030
-5.030
5.030
25.302
10
178.303
51.696
51.696
2672.578
11
179.193
45.806
45.806
2098.229
12
203.832
20.167
20.167
406.742
13
204.605
MSE
578.03
MAPE
6.145
MAD
18.478
Forecast for the 1st quarter of the next year is 204.605

(vii) Trend and Seasonality-corrected exponential smoothing:
Applicable when demand consists of level, trend and
seasonality in the systematic component, i.e.
Systematic component = (level + trend) X seasonal factor
The forecast for future period (t+1) is given by
and
On observing demand for period (t+1), the estimates of level,
trend and seasonal factors are computed as follows:
is a smoothing constant for level (0<=<=1), is a

smoothing constant for trend and is the same for seasonality
(0<=<=1).
17
9/24/2012

Example: Refer to example 6 of the main text. The value of = 0.2, = 0.3
and = 0.4. The initial estimates of level and trend are 183.73 and 0.8913
respectively.
Forecasting through trend & seasonality-corrected exponential smoothing
Period
Initial deseasonalized
Dt = L 0 + T 0 * t
Deseasonalized
demand (Dt)
Demand (D)
Seasonality (St)
( St )
Average seasonality
0
1
200
184.6213
1.083298623
1.015929515
190
185.5126
1.024189193
1.047884137
180
194.375
186.4039
0.965645032
1.007704009
210
191.875
187.2952
1.121224676
1.058172853
195
188.75
188.1865
1.036206104
1.037163397
175
182.75
189.0778
0.925544934
1.03464023
170
175.875
189.9691
0.894882378
0.990771668
172
180.625
190.8604
0.901182225
1.078571495
178
194.375
191.7517
0.928283817
1.032631307
10
230
207.75
192.643
1.193918284
0.995522002
11
225
193.5343
1.162584617
0.964848198
12
224
194.4256
1.152111656
1.033907944
13
1.026909978

Level
Period
Trend
Forecast
Error
Absolute error
Squared error
183.753
0.891
187.088
1.6244
187.5856
12.4144
12.4144
154.11747
187.233
1.1807
197.7491
-7.7490
7.74908
60.048268
186.456
0.5933
189.8661
-9.8660
9.8660
97.339394
189.330
1.2776
197.931
12.0690
12.0690
145.66169
190.089
1.1219
197.6922
-2.6921
2.6921
7.2479091
186.797
-0.2022
197.8349
-22.8349
22.8349
521.43397
183.592
-1.1029
184.873
-14.873
14.873
221.20599
177.885
-2.4841
196.8282
-24.8282
24.8281
616.43740
174.796
-2.6657
181.1252
-3.1252
3.1252
9.766942
10
183.911
0.8685
171.3598
58.6402
58.6402
3438.67308
11
194.463
3.7735
178.2846
46.7154
46.7154
2182.3331
12
201.920
4.8785
204.9587
19.04127
19.0412
362.56984
13
Mean error
5.2426
212.3638
MAD
19.570
MSE
651.40
MAPE
9.636
Forecast for the first quarter of the next year is 212.3638
18
9/24/2012
Selection of a particular forecasting tool

The thumb rule indicates that the manager should choose that
particular method which would produce minimum forecast error.
Availability of several measures of forecast errors which produce
different results of forecast error.
Which measure should be given more importance is a matter of
judgment and discretion to be exercised by the manager.
Overall steps to be followed for choosing a particular forecasting tool:
(i) Short listing of a few forecasting methods based on the patterns
of demand observed in the recent past.
(ii) Prioritizing the measures of forecast error based on the
preferences of the manager.
(iii) Comparison of forecast error values on the prioritized measures of
forecast error.
Procurement Decision
Module 2, Section 2
19
9/24/2012
Broad outline
Overview on procurement
Procurement cycle
Vendor evaluation and selection
Case study on vendor evaluation
Major proportion of working capital remains blocked in the
form of raw materials and other inputs while procuring the
same from different sources.
The most important aspect of procurement is the quality and
the quantity of inputs.
If the input items are procured in insufficient quantity, the firm
may fail to deliver the required quantity of finished goods to its
customers in time.
If the same is procured in excess, the firm will have to bear
additional financial burden in terms of the opportunity cost of
funds tied in unused items, inventory carrying cost etc.
20
9/24/2012
The capacity of the supplier in terms of infrastructural
facilities, financial resources, technological knowhow,
commitment towards quality, delivery schedule etc. need to
be properly ascertained.
Procurement involves sourcing right material from right
supplier/s in right time with right quantity.
Procurement cycle
Step 1: Identification of requirements of an item by User
Department in terms of type, quality and quantity etc.
Step 2: Identification of the right sources of supply and
invitation of quotations.
Step 3: Comparison of quotations, negotiation with the
vendors and placing of purchase order.
Step 4: Keeping track of purchase order.
Step 5: Inspection of quality, quantity etc. and receipt of
purchase order.
21
9/24/2012
Vendor evaluation
Vendor evaluation, a strategic issue in view of its potential in
improving overall supply chain performance attempts to
(i) reduce the risk and uncertainty associated with procurement,
(ii) maximize overall value to the organization and
(iii) build long-term relationship with suppliers.
List of supplier evaluation criteria considered important from the

perspective of different researchers are as follows:
Price
Quality / Reliability of the product
Technical support / After sales support
Ability to meet delivery schedule / Delivery lead time
Vendor evaluation
Quality system at suppliers place/ quality policy /quality philosophy

Technological capability / Innovation capability / R & D capability
Breadth of product line / Ability of a supplier to supply a number of items
Sensitivity of suppliers to buyers requirements
Willingness of suppliers to share information
Existence of IT / Communication system
Integrity of vendor/ Vendors image
Financial capability of the supplier
Business volume / Amount of past business
Geographic proximity of suppliers
Support in new product development
22
9/24/2012
Case study on vendor evaluation

Study conducted in a large Engineering Organization
primarily engaged in manufacture of diesel locomotives.
Large number of high value and critical (Strategic) items are
purchased from different suppliers.
Stores and Purchase department professionals were
consulted about the practices being followed
List of criteria was shown to the professionals.
Finally list of criteria made relevant to the organization.
Objective
Identification of supplier evaluation criteria
Major
Criteria
C2
C1
C11
C12
C13
C14
C21
C22
C23
C24
C3
C15
C4
C41
C42
C43
Sub- Criteria
C31
C32
C33
C34
C35
Major Criteria: C1: Technical factors;

C2: Commercial factors;
C3: Communication & miscellaneous support provided by
suppliers;
C4: Financial performance of suppliers
Sub-Criteria: C11: Quality/Reliability;
C12: Quality system at suppliers place;
C13: Technological capability and innovation of suppliers; C14: Breadth of product line;
C15: Technical support/After sales support
C21: Price;
C22: Ability to meet delivery schedule;
C23: Payment terms and conditions;
C24: Geographic proximity
C31: Service response time; C32: Sensitivity of suppliers to buyers requirement;
C33: Willingness of suppliers to share vital information;
C34: Support in Value Engineering
C35: Support in developing new product specification
C41: Financial capability of suppliers;
C42: Suppliers volume of business with the buyer with respect to suppliers turnover;
C43: Suppliers volume of business with respect to buyers total annual turnover
Figure 1: Hierarchy of supplier evaluation criteria
23
9/24/2012
Case Study on vendor evaluation

Eliciting opinions from the Experts:
Three top-most Executives from Stores and Purchase
department identified as Experts.
Explained the purpose of the study and pair-wise comparison of
AHP as explained by Saaty.
The Experts show their preferences in terms of linguistic
variables suggested by Saaty, such as Very high, High etc.
Table 1 : Composite weights of supplier evaluation criteria
Sub-Criteria
C11
C12
C13
C14
C15
C21
C22
C23
C24
C31
C32
C33
C34
C35
C41
C42
C43
Composite
.239
.0245
.135
.045
.082
.153
.072
.032
.017
.051
.043
.021
.010
.0062
.015
.043
.005
Weights
Evaluation of suppliers
Evaluation
criteria
Importance
weight
Performance rating of the suppliers

S1
S2
S3
S4
S5
S1
S2
S3
C11
0.239
1.195
0.956
0.717
C12
0.0245
0.1225 0.098
C13
0.135
0.675
0.540
C14
0.045
0.180
0.180
C15
0.082
0.410
C21
0.153
C22
0.072
C23
0.032
C24
0.017
C31
0.051
C32
0.043
S4
S5
0.956
1.195
0.098
0.098
0.1225
0.540
0.675
0.540
0.180
0.135
0.180
0.328
0.328
0.246
0.328
0.612
0.459
0.765
0.612
0.612
0.288
0.360
0.360
0.288
0.360
0.160
0.128
0.160
0.128
0.128
0.051
0.068
0.085
0.068
0.068
0.255
0.255
0.153
0.255
0.255
0.215
0.129
0.086
0.172
0.215
Factor Scores of the suppliers
24
9/24/2012
Evaluation of suppliers (Contd.)

Evaluation
criteria
Importance
weight
Performance rating of the suppliers

S1
S2
S3
S4
S5
Factor Scores of the suppliers

S1
S2
S3
S4
S5
C33
0.021
0.084
0.084
0.063
0.105
0.084
C34
0.010
0.050
0.030
0.020
0.030
0.050
C35
0.0062
0.031
0.0248 0.0186 0.0248
0.031
C41
0.015
0.075
0.075
0.045
0.060
0.075
0.043
0.215
0.129
0.086
0.129
0.172
0.005
0.025
0.020
0.015
0.020
0.025
C42
C43
Total Factor scores secured by the suppliers
4.6435 3.8638 3.7196 4.0018
Overall Rank of the suppliers
4.4405
Managing inventory in a supply

chain
Module 2, Section 3
25
9/24/2012
Broad outline
Meaning of inventory in the context of Operations &
Supply Chain
Inventory types
Inventory-related costs
Basic EOQ model
Capturing uncertainty: Safety stock
(i) Safety stock in case of Continuous review policy
(ii) Safety stock in case of Periodic review policy
(iii) Impact of service level on safety stock
(iv) Impact of demand and supply uncertainty on safety stock
Managing inventory for short life-cycle products

Selective inventory control
Vendor managed inventory (VMI)
Inventory: An overview
Vital element of any organization which enables it
- to run its operation in an uninterrupted manner and
- to provide a satisfactory level of service to its customers.
The issue is how much inventory should an organization

keep too much or too little?
Trade-off between providing good customer service versus
achieving operating efficiency.
Performance measures of inventory management: inventory
turnover ratio.
Generally higher the ratio, the better is the performance.
Desirable number of turns depends on the type of industry
and the amount of profit margins.
High-end retailers have a low turnover rate while
supermarkets have a fairly high turnover rate.
26
9/24/2012
Inventory types
On the basis of physical characteristics (or accounting
classification), inventory is divided into three main types:
- Raw materials and purchased parts
- Work-in-process (WIP) goods
- Finished goods
On the basis of functional classification
- Cycle inventory
- Safety inventory
- Pipeline inventory
- Anticipation inventory
- Decoupling inventory
Inventory related costs

Ordering costs:
Costs associated with the preparation of purchase order, getting the
necessary approval for placing the purchase order, actual placing of
the order and follow-up of the same.
Carrying costs:
Costs incurred in connection with the physical storage of items.
Shortage costs:
Costs incurred by the firm when demand exceeds supply of inventory
on hand. There are two types of shortage costs:
(i) lost sales cost and
(ii) backorder cost.
27
9/24/2012
Basic EOQ model

Assumptions of the basic EOQ model:
- Only one product is involved

- Annual demand requirements are known
- Demand is even throughout the year
- Lead time does not vary
- Each order is received in a single delivery
- There are no quantity discounts
The Inventory Cycle

Q
Profile of Inventory Level Over Time
Usage
rate
Quantity
on hand
Reorder
point
Receive
order
Place
order
Receive
order
Place
order
Receive
order
Time
Lead time
28
9/24/2012
Basic EOQ model

Notations:
D: Annual demand
A: Setup or Order Cost
C: Cost per unit
h: Holding cost per year as a percentage of unit product cost
H: Inventory carrying costs per unit per year = h*C
Q: Lot Size
T: Reorder interval
Number of orders per year = D/Q
Annual material cost = C*D
Annual order cost = (D/Q)*A
Annual holding cost = (Q/2)*H
Total annual variable cost (TC) = (D/Q)*A + (Q/2)*H
Cost Minimization Goal
Annual Cost
The Total-Cost Curve is U-Shaped

Q
D
TC= H + A
2
Q
Ordering Costs
QO (optimal order quantity)
Order Quantity (Q)
29
9/24/2012
Basic EOQ model

The total cost curve reaches its minimum where the carrying
and ordering costs are equal, i.e.
Q/2 *(H) = (D/Q)*A
i.e.
Key insights:
Total cost curve is relatively flat in the vicinity of EOQ. This indicates that
the total cost is not particularly sensitive to the optimal order quantity.
In deciding the optimal lot size, the tradeoff is between order (set-up) cost
and holding cost.
If demand increases by a factor of k, it is optimal to increase batch size by
a factor of Sqrt k.
If lot size is to be reduced, one has to reduce fixed order cost.
Safety stock
Takes care of variability in demand and supply lead time.
Reduces the risk of stockout during lead time.
The determinants of safety stock and reorder point are as
follows:
- The rate of demand
- The lead time
- The extent of demand variability
- The extent of lead time variability
- The degree of stockout risk acceptable to the management or the level
of service to be provided to customers.
30
9/24/2012
Safety stock
Safety stock: continuous review policy

Popularly known as Q model or FOQ model or ROP model.
Relevant policy is known as (s, S) or (s, Q) policy. s and S
stand for reorder point (ROP) and order upto level (OUL)
respectively while Q indicates order quantity. The
relationship is as follows:
S=Q+s
ROP: Sum of the expected demand during lead time and safety
stock which is determined in case of ROP or FOQ model.
OUL: Expected demand during lead time and review period.
31
9/24/2012
Continuous review policy

Notations:
= average daily/weekly demand
sd = standard deviation of daily/weekly demand
sdLT = standard deviation of demand during lead time
LT = replenishment lead time in days/weeks
=average replenishment lead time in days/weeks
sLT = standard deviation of lead time
h = holding cost of one unit per period
A = fixed cost
SL = Service level (for example, 95%). This implies that the probability of
stocking out is 5%
SS = Safety inventory
s = Reorder point (ROP)
S = Order upto level
z = standard normal variable corresponding to a particular service level
provided to customers
32
9/24/2012

Normally utilized when the items purchased or handled are
expensive in nature and
Management needs to closely monitor the level of its
inventory on a continuous basis.
Case 1: Only demand is variable
Average demand during lead time =
Safety stock (SS) =
ROP (s) =
+
Order upto level (S) = Q + s

Case 2: Only lead time is variable
Safety stock (SS) =
ROP (s) =
+
33
9/24/2012

Case 3: Both demand and lead time is variable
Safety stock (SS) =
ROP (s) =
+
Periodic review policy

Applicable for most of the retail stores handling FMCG or groceries.
Also known as fixed order interval (FOI) model and the relevant
policy is known as periodic review policy or base stock policy.
Orders for the items are placed at fixed intervals.
Inventory level is also checked only in those intervals.
Order upto level remains fixed.
Order quantity computed on the basis of order upto level and
inventory level on hand at fixed intervals.
The amount of safety inventory to be kept in this model is much
higher than that in case of FOQ model. Because the safety
inventory has to cover the period of lead time plus the fixed order
interval.
34
9/24/2012

The base-stock level includes two components:
Average demand during (r+LT) period (the time until the next
order arrives): (r+LT)*d
Safety stock during that time: z* sd * (r+LT)
Items from the same supplier may be clubbed together, which
yield savings in ordering costs, packaging costs, shipping costs,
handling costs and other related administrative costs.
35
9/24/2012
Impact of service level on safety stock

Service level is the probability that all orders will be filled
from stock during the replenishment lead time or during the
reorder cycle.
A retailer has specified a service level of 95 percent. This
implies that during 100 such reorder cycles, we can expect
stock out situation in about five cycles.
A firm keeping a higher level of safety factor is in a position to
provide higher level of customer service.
Service level increases as the level of safety inventory
increases.
The marginal increase in service level in the initial period is
higher than that in the later period.
Impact of service level on safety stock
36
9/24/2012
Impact of demand and supply

uncertainty on safety stock
Variability in demand and lead time has an important bearing
on the amount of safety stock to be kept by a firm.
The absolute value of lead time also has an impact on the
amount of safety stock to be maintained.
Reduction in variability of supplier lead time provides highest
benefits to the firm in terms of minimizing safety stock
requirement.
Reduction in variability of demand is not a significant driver in
minimizing safety stock requirement.
Reduction in average lead time does not have much impact in
minimizing safety stock requirement.
Impact of demand and supply

uncertainty on safety stock
Average
daily
demand
S.D. of
daily
demand
Average
lead time
(days)
S.D. of
Safety
stock
Safety stock
in days
Remarks
lead time
500
100
20
4990
9.98
Base case
500
100
20
736
1.472
No supply
uncertainty
500
20
4935
9.87
No demand
uncertainty
500
50
20
4949
9.898
Reduce demand
uncertainty
500
100
20
2575
5.15
Reduce supply
uncertainty
500
100
10
4962
9.924
Reduction in lead
time
37
9/24/2012
Managing inventory for short life-cycle

products
Special category of items for which demand occurs for
a very short period.
The problem of managing inventory in a single period
with uncertain demand widely known as newsvendor
problem.
Goods are to be kept ready before the selling season
starts in order to take care of the demand.
Opportunity does not exist to place a second order
during the selling season.
The issue is: how many items should the manager
order before the selling season starts?
Examples: fashion products, high technology products,
perishable goods etc.
Managing inventory for short life-cycle

products
Co = overage cost = (Cost Salvage value)
increase in profit you would have enjoyed had you
ordered one fewer unit.
Cu = underage cost = (Selling Price Cost)

increase in profit you would have enjoyed had you ordered one
more unit.
Critical ratio is Cu / (Co + Cu)

This ratio implies the optimum level of service from
which the value of standard normal variable (z) is found
out.
Optimum order size = Mean demand + z*standard
deviation of demand
38
9/24/2012

ABC classification:
Items are classified into A, B and C category based on the
annual consumption value of items.
A category items: High value items and constitute roughly
10% of the whole items but account for approx. 70% of the
total annual consumption value.
B category items: Medium value items and account for
approx. 20% of the whole items and contribute towards 20%
of the annual consumption value.
C category items: Low value items and constitute roughly
70% of the items and account for only 10% of the annual
consumption value.

ABC classification:
39
9/24/2012

VED classification:
Items are segregated on the basis of criticality of the items
specified by the end users.
V indicates vital items without which the entire functioning
of the plant or the machine gets severely affected.
E indicates essential items required by the end users.
D denotes desirable items from the point of view of the end
users.
This classification is quite popular in maintenance
management.

FSN classification:
Items are classified based on the volume of consumption.
F indicates fast moving items
S indicates slow moving and
N indicates non-moving items.
Fast moving items generally kept in all decentralized stores.
Slow moving items generally stocked in a centralized store.
Non-moving items need to be disposed off gradually.
40
9/24/2012

SDE classification:
Items are classified based on their availability in the market.
S means scarce to obtain, which further implies that the items
are probably available in international market.
D implies difficult to obtain, which indicates that the items are
probably available in the national market.
E indicates easy to obtain, which implies that the items are
probably available in local markets.
Helps in developing suitable sourcing strategies for different
category of items.
Vendor managed inventory (VMI)

Inventory management jointly agreed upon by a retailer and a
supplier which ensures minimum mismatch between demand
and supply.
Supplier takes the entire responsibility of determining when to
replenish and how much to replenish at the retail store.
The supplier also decides about the right inventory policy.
The retailer will have to share actual demand data with the
supplier through EDI, which helps improve the forecast.
Supplier owns the inventory as long as the goods are lying in
the shelves of retailer.
One of the shortcomings of VMI is the sale of substitute
products of the competing manufacturers by the retailers.
41
9/24/2012
Materials Requirements Planning

(MRP)
Module 2, Section 4
Broad outline
An overview on MRP
MRP inputs
MRP processing
MRP outputs
MRP II
42
9/24/2012
An overview on MRP
A computer based information system that converts a master
schedule of end products into time-phased requirements of
sub-assemblies, components and raw materials.
Procurement lead time of input items and assembly time of
sub-assemblies are considered for timely completion of end
items.
Also known as dependent demand estimation method.
An overview on MRP
An MRP system is designed to meet simultaneously three
objectives:
Ensure inputs are available for production and end items are
manufactured for delivery to customers in time.
Maintain the lowest possible level of inventory.
Prepare delivery schedules and accordingly plan manufacturing and
purchasing activities.
It provides answers to the following three questions:

WHAT is needed?
HOW MANY/HOW MUCH is needed?
WHEN is it needed?
43
9/24/2012
An overview on MRP
MRP inputs
MRP processing
Master
schedule
Bill of
Materials
MRP outputs
Order release
requirements (orders
to be released now)
MRP
computer
Order rescheduling
(expedite,
deexpedite, cancel
open orders
Inventory
records
Planned orders
(future)
MRP inputs
(i) a master production schedule, which provides the
details of how much end items are desired and when,
(ii) a bill-of-materials file, which tells the composition of a
finished item,
(iii) an inventory record file, which shows how much
inventory is on hand or on order.
44
9/24/2012
Master Production Schedule (MPS)

Developed on the basis of aggregate production plan.
Also gets inputs from specific customer orders
Specifies which end items are to be produced, how many
quantities are needed and when the same is to be delivered.
Divides the planning horizon into a series of time periods or
time buckets, which are often expressed in weeks.
Week number
Item: P
Quantity
50
90
80
The schedule indicates that 50 units of P will be needed in

week 2, 90 units in week 4 and another 80 units in week 6.
Bill of Materials (BOM)

Provides a clear idea about the composition of a product.
The list of items in BOM is hierarchical.
Shows the quantity of each item needed to complete one unit
of an item upstream.
The diagram below shows an assembly diagram for a sofa and
its product structure tree.
Sofa
Leg assembly
Legs (4)
Cross bar (2)
Seat
Side rail (2)
Back assembly
Cross bar (1) Back support (2)
45
9/24/2012
Inventory record file

Refers to the information relating to the status of each item
by individual time period.
Includes the quantity of the item available in the store, gross
requirements, scheduled receipts, projected available balance
etc.
Also includes information on procurement lead time of the
item, setup time of each production run, run time for each
sub-assembly or assembly etc.
Changes due to new orders, cancelled orders, stock receipt
and withdrawal etc. are to be recorded in the inventory record
file.
MRP Processing
Main purpose of MRP processing is to determine the net
requirements of items in right time periods.
Considers the requirements of end products specified by MPS
and explodes them into time-phased requirements of subassemblies, components etc.
Quantities estimated through exploding the BOM are gross
requirements.
Net requirements are computed as
Net requirements in period t = Gross requirements in period t
Projected on-hand inventory in period t + Safety stock
46
9/24/2012
MRP Processing
MRP processing takes place through the following list of items.
Gross requirements: indicates the total expected demand for an
item during each time period regardless of the quantity available
on-hand.
Scheduled receipts: indicates the open orders scheduled to arrive
from the vendors.
Projected available balance: implies the expected amount of
inventory that will be on hand at the beginning of each time period.
Net requirements: shows the actual amount needed in each time
period.
Planned-order receipts: tells the quantity expected to be received at
the beginning of each period in which it is shown.
Planned-order releases: indicates a planned amount to order in
each time period which equals the planned-order receipts offset by
lead time.
MRP Processing
Week number
Gross requirements
Scheduled receipts
Projected on hand
Net requirements
Planned order receipts
Planned order releases
47
9/24/2012
MRP Outputs
Primary reports: considered to be the main report
Planned orders: a schedule indicating the amount and timing of future
orders
Orders releases: authorization for the execution of planned orders
Changes: Change in due dates or order quantities or cancellation of
orders.
Secondary reports: considered to be the optional outputs
Performance-control reports: Evaluation of system by measuring the

deviations from plans.
Planning reports: Useful for assessing future material requirements.
Exception reports: Reports on major discrepancies such as late orders, late
delivery, excessive scrap rates etc.
Material requirements can be computed using both lot-for-lot ordering and

lot-size ordering.
Manufacturing Resources Planning

(MRP II)
MRP does not include the feasibility of a plan.
MRP II includes all essential elements of MRP. In addition, it
also incorporates the valuable inputs from other functional
areas like marketing, finance etc.
Purpose is to devise a production plan which is practical,
feasible and implementable.
MRP II enables managers to test what-if scenarios by using
simulation.
48
9/24/2012
Logistics & Transportation

Management
Module 2, Section 5
Broad outline
Logistics: A brief overview

A brief concept of transportation
Drivers of transportation decisions
Impact of speed on transportation decisions
Impact of demand uncertainty on transportation decisions
Distribution network design
Comparison of distribution network design options
Other distribution networks in practice
Warehousing & its different types
49
9/24/2012
Implies the movement of supplies of arms, ammunitions, food, medicines

and other essentials from one place to another in the context of military
operations.
In the context of business operations, it implies the movement of raw

materials, components, semi-finished and finished goods from one region
to another within a country or from one country to another.
Council of Supply Chain Management Professionals (CSCMP) has defined

logistics as
The process of planning, implementing and controlling the efficient, cost
effective flow and storage of raw material, in-process inventory, finished
goods and related information from the point of origin to the point of
consumption for the purpose of conforming to customer requirements.

Components of logistics function are
transportation,
warehousing,
packaging and material handling.
Logistics activities are divided into two broad functions
inbound logistics or physical supply

concerned with bringing materials, components etc. from sources
of supply to the processing or the manufacturing plant and
outbound logistics or physical distribution
concerned with the movement of finished goods from the
processing plant to the distribution centres and subsequently to the
retail stores.
50
9/24/2012

Logistics costs account for 13% of GDP in India
compared to 8-9% of GDP in the US.
The inefficiencies in the logistics industry arise from
(i)
(ii)
(iii)
(iv)
(v)
a fragmented market,
multiple taxes,
physical infrastructure bottlenecks,
archaic labour laws, and
state-centred policies.
The industry is growing at a rate of 8-10% per annum

and is expected to reach a size of $385 billion by 2015.
Transportation
Transportation constitutes the largest element and accounts
for maximum cost of logistics.
Transportation decision depends on the supply chain network
design of a firm.
Transportation-related decisions have a direct impact on
supply chain efficiency and supply chain responsiveness of a
firm.
51
9/24/2012
Transportation
A firm desirous of becoming responsive has to set up
warehouses and retail stores at many places which increases
operations and maintenance cost and inventory carrying cost
at the facilities. However, this reduces transportation cost.
A firm emphasizing upon efficiency will need to set up few
distribution centres and warehouses. This will minimize
operations and maintenance cost and inventory carrying cost
at the facilities. However, transportation cost is likely to
increase.
Drivers of Transportation decisions

Transportation cost
Value density (weight, volume, chemical properties etc.)
Patterns of demand (Volume of demand and the variability in
demand)
Mode of transportation (in terms of cost, speed, capacity,
reliability etc.)
52
9/24/2012

Transportation cost: depends on
(i) the distance to be moved by the item from origin to
destination,
(ii) total quantity of the same item carried in the vehicle
etc.
- Marginal cost of transport decreases, as longer

distance is covered. This is technically known as
economies of distance.
- Unit cost of transportation also decreases, if the
vehicle is moved in full truck load (FTL) mode rather
than in less-than truck load (LTL) mode, also known as
economies of scale.

Value density
reveals the importance of transportation cost in the overall
product cost. It captures transportation-inventory trade-off.
(i) High value-density items

Examples: gold, diamond, high technology products etc.
- Transportation cost constitutes a small percentage of the
overall cost of the product.
- Firms can use faster and expensive mode of transportation.
53
9/24/2012

(ii) Medium value-density items
Examples: FMCG, consumer durables etc.
- Transportation cost constitutes a moderate percentage of the
overall cost of the product.
- Firms use neither very fast nor very slow mode of transport
but attempt to choose between these mode two modes.
(iii) Low value density items

Examples: coal, iron ore, cement etc.
- Transportation cost accounts for a significant percentage of the
total product cost.
- Firms use slower mode of transportation.

Patterns of demand
(i) Volume of demand (cycle stock)
- FTL mode of transport for products with volume of demand.

- LTL mode of transport for products with low volume of demand.
(ii) Uncertainty associated with the product demand (safety

stock)
(iii) Long lead time (high safety stock)
- Faster mode of transport for products with high demand

uncertainty
- Slower mode of transport for products that have a stable demand
54
9/24/2012

Mode of transportation
- Rail
- Road
- Air
- Water
- Pipeline
Mode of transportation (Rail)
Suitable for low value-density products

Long and unreliable lead time
Off-track delays (at pickup and delivery end)
Indian railways is the second largest rail network in the world.
Accounts 30% of freight movement in India
Very high in-transit damages and losses
95% of the freight carried is in bulk goods and within that coal
accounts for 50% of the traffic.
55
9/24/2012
Mode of transportation (Road)

India accounts for the second highest network of roads in
the world.
National highways constitute only 2% of the total roads, but
carry almost 40% of the traffic.
80% of the roads considered as village roads.
Trucks account for about 65% of freight movement in India.
More expensive than rail, but offers the advantages of
door-to-door delivery and shorter delivery time
Low freight rate and poor quality of service
Unreliable transit time
High in-transit damages.
Mode of transportation (Air)

Expensive
Rapid and reliable delivery
Small, time-sensitive and high value-density goods
Preferred mode for e-businesses (e.g., Amazon, Dell etc.)
Consolidation of shipments (especially important for
package carriers that use air as a primary method of
transport)
air transport contributes a very small percentage towards
freight movement in India but expected to play a
significant role in near future.
56
9/24/2012
Mode of transportation (Water)

One of the cheapest modes of transport
Very large loads at very low cost
Slowest amongst all.
Limited to certain geographic areas
Ocean, inland waterway system, coastal waters
Considerable delays at ports in loading and unloading
Extensively used for international cargo.
the amount of cargo handled by the Indian ports is very low
compared to the International standard.
The amount of cargo handled by the Indian ports is very low
compared to the International standard.
Mode of transportation (Pipeline)

High fixed cost
Primarily used for transportation of crude petroleum,
refined petroleum products, natural gas etc. when the
point of origin and the point of destination remain same.
Best for large and predictable demand
Used for getting crude oil to a port or refinery, but not for
getting refined gasoline to a gasoline station.
Losses and damages also remain at a very minimum level.
Unit cost of transportation is also very low.
In India, pipelines are being laid to transport gases and
petroleum products to different places.
57
9/24/2012
Comparison of transportation modes on SC

performance measures
Freight cost
Lot size
Delivery time
Delivery time variability
Losses and damages
Relative ranking of modes of transportation

by performance measures
Mode of
transportation
Cost (1 =
least)
Lot size (1=

smallest)
Delivery
time (1=
fastest)
Delivery time
variability (1=
least)
Loss and
damage
(1=least)
Rail
Road
Water
Air
58
9/24/2012
Total cost approach to performance measures

Total cost =
Transportation cost + Cycle stock inventory
carrying cost + Pipeline inventory carrying cost
+ Safety stock inventory carrying cost + Cost of
losses and damages
Impact of speed on transportation

decision
Delivery time has a significant impact on the
choice of transportation mode.
High-value products should be shipped by a faster
mode of transport.
Low-value items should be shipped by a relatively
cheaper mode of transport.
59
9/24/2012
Cost comparisons of two modes of

transport under stable demand
An export-oriented garment manufacturing unit located in Ludhiana
manufactures two types of garments, viz. premium garment and lowend garment and exports the same to European and American
markets. It considers two modes of transport, air and sea. It takes four
weeks to ship the goods to either Europe or America from Ludhiana, if
the same is sent by sea. However, shipping via air takes only one week.
If the firm decides to use air as the mode of transport, it can fly the
goods in smaller lots of 400 units, while shipping via sea requires a
minimum shipment size of 2000 units. The premium garment and lowend garment cost Rs. 2000 and Rs. 500 per unit respectively. The
demand of premium garment and low-end garment is 100 units and
200 units per week respectively in the export market. Freight by air will
be Rs. 100 per unit while the same by sea will be Rs. 25 per unit. The
annual inventory carrying cost is 20% of the cost of the item. Consider
52 weeks in a year.
Cost comparisons for two modes of

transport under stable demand
Product
Mode of Cycle
transport stock
Pipeline
stock
Average
inventory
Inventory
carrying cost
in Rs (annual)
Transportation
cost in Rs.
(annual)
Total cost
per annum
in Rs.
Premium Sea
garment
Air
1000
400
1400
560,000
130,000
690,000
200
100
300
120,000
520,000
640,000
Low end Sea

garment
Air
1000
800
1800
180,000
260,000
440,000
200
200
400
40,000
1040,000
1080,000
60
9/24/2012
Impact of demand uncertainty on

transportation decisions
Continue with the same example of premium and low-end
garments under stable demand. Assume that instead of the
weekly demand of the premium and low-end garments in
Europe and America being uniform, the same exhibits
randomness. Further assume that the weekly demand data
given in the previous example represent average demand of
premium and low-end garments. The standard deviation of
weekly demand of premium and low-end garments is 80
and 50 respectively. The firm is targeting a service level of
95%. (For 95% service level, consider the value of z = 1.645).
Cost comparison of two modes of

transport under uncertain demand
Product
Mode of
Safety stock Safety stock
transport
Premium
garment
Total cost per annum
carrying cost
under stable demand
Total cost
Sea
263.2
105,280
690,000
795,280
Air
131.6
52,640
640,000
692,640
Low
end Sea
garment
Air
164.5
16,450
440,000
456,450
82.25
8,225
1080,000
1088,225
61
9/24/2012
Distribution network design

To decide how the items should be delivered to the
final customers.
To find out how many distribution centres/
warehouses are to be set up and where the same
should be located.
To ship the goods to the geographically dispersed
market areas in a cost-effective manner by evaluating
different distribution network options:
- Direct shipment network
- Direct shipping with milk-runs
- Shipment via Central Distribution Centre
Direct shipment network

Stable demand with high volume
High cycle inventory
Goods are supplied in FTL mode in this network in order to
derive economies of scale in transportation.
Suppliers
Demand centres
62
9/24/2012
Direct shipping with milk-runs

Essentially a route on which a truck either delivers an item
from a single supplier to multiple retailers/distribution centres
or from multiple suppliers to a single retailer/ distribution
centre.
Increase in frequency of visit
Increase in transportation cost
Low cycle stock because shipment size of an individual item
reduces due to the consolidation of several items in a single
truck.
Low inventory carrying cost.

Supply to multiple demand centres from a single supplier
Example: Delivery of milk by milk-delivery van to several outlets
of Mother-Dairy.
Suppliers
Demand centres
63
9/24/2012

Supply from multiple suppliers to a single demand centre.
Example: Supply of auto-components from multiple suppliers to
the Toyota plant.
Suppliers
Demand centres
Shipment via Central Distribution Centre

Suitable when the distance from the suppliers to the demand
centres is very high and at the same time replenishment to the
demand centres has to be made on a frequent basis.
Provides the benefit of economies of scale in inbound
transportation because supply is made to the central
distribution centre on FTL mode.
During outbound transportation, shipment size of an individual
item becomes smaller because a single truck is loaded with all
the items received from all suppliers in FTL mode.
Cycle stock almost similar to Milk Run option.
Transportation cost generally higher than Direct shipping, but
lower than Milk Run option.
Setting up of an additional facility at DC.
Additional loading and unloading costs at DC.
64
9/24/2012
Shipment via Central Distribution Centre

Shipping via central distribution centre
Suppliers
Demand centres
P
B
DC
C
Comparison of distribution network design

options
XYZ Company is having its manufacturing facilities of three different cars
namely hatchback, entry level sedan and high level sedan cars at three
different places namely Faridabad, Manesar and Gurgaon respectively. It
serves primarily three markets, Delhi, Noida and Greater Noida and
accordingly sends finished cars to the three depots located at Delhi, Noida
and Greater Noida. Weekly demand at each of these depots is 20 units of
hatchback cars, 10 units of entry level sedan cars and 5 units of high level
sedan cars. The distance of Delhi, Noida and Greater Noida depot from
Faridabad plant is 45 kms, 50 kms and 55 kms respectively. And the distance
of Delhi, Noida and Greater Noida depot from Gurgaon plant is 50 kms, 55
kms and 60 kms respectively. Further the distance of Delhi, Noida and Greater
Noida depot from Manesar plant is 80 kms, 85 kms and 90 kms respectively.
The distance between Delhi and Noida depot is 25 kms and that between
Noida and Greater Noida is 15 kms. The company is contemplating to set up a
distribution centre (DC) somewhere in the mid-point between the plants and
the depots. The distance of this DC from Faridabad, Gurgaon and Manesar
plant is expected to be 25 kms, 28 kms and 40 kms respectively. Further the
distance of Delhi, Noida and Greater Noida depots from the DC is expected to
be 25 kms, 30 kms and 35 kms respectively.
65
9/24/2012

options
The company is considering three strategies for shipping the finished
cars from its plants to the depots, viz. (i) Direct shipping, (ii) Shipping
through milk run and (iii) Shipping through a distribution centre.
Imagine that a very big truck can carry 60 units of hatchback cars or 30
units of entry level sedan cars or 15 units of high level sedan cars in
FTL shipment or it can bundle 20 units of hatchback cars, 10 units of
entry level sedan cars and 5 units of high level sedan cars in FTL
shipment. The transportation cost is Rs.10 per km for FTL shipments.
To obtain economies of scale, the company has decided to work with
FTL shipments. The inventory carrying cost of hatchback, entry level
sedan and high level sedan cars is Rs. 5000, Rs. 10,000 and Rs. 15,000
per unit per year. If the company decides to ship through distribution
centre, then it will have to set up a cross-docking centre for which
facility cost of Rs. 50,000 will be incurred every year. Consider 52
weeks in a year.

options
Option
Distance
traveled
in one
cycle
(kms)
Frequency of
transport
cycle
Annual
transport
cost (Rs.)
Annual
facility
cost
Annual
Inv. cost
Annual
Total cost
Direct
shipping
1140
Once in three
weeks
197,600
1237,500
1435,100
Milk Run
500
Once a week
260,000
412,500
672,500
Shipping
via DC
366
Once a week
190,320
50,000
412,500
652,820
66
9/24/2012
Other distribution networks

Cross docking:
Popularized by Wal-Mart and now currently it is being utilized
by a number of organizations worldwide.
Appropriate for products with high, predictable and stable
demand.
Used for facilitating the movement of goods from a set of
suppliers to the set of buyers.
Inbound truck carries a product from a supplier to the crossdocking centre in FTL mode.
Cross docking (Contd.)

Outbound truck loaded with different products of different
suppliers in FTL mode at cross-docking point.
Provides the benefit of economies of scale in both inbound
and outbound transportation.
Product flows faster from supply sources to the demand
centres and inventory is held at the cross-docking centre for
12-14 hours only.
It requires a significant degree of coordination and
synchronization between incoming and outgoing trucks.
67
9/24/2012
Hub & Spoke Model

Suitable for airlines and postal services.
Hub is considered to be the centralized point wherein all
operations like sorting of parcels, segregation of passengers
etc. are carried out.
Spokes indicate different routes to be followed for shipping
products to different locations.
One of the disadvantages of this network is that all parcels or
passengers will have to come to the hub first irrespective of
the locations of the originating station.
To overcome this limitation, sometimes firms may attempt to
create regional hubs at different regions.
Warehousing
An operation that receives, sorts, stores, or centralizes goods
for the purpose of storage or for facilitating the movement of
goods from sources to final destinations.
Warehouses are used to reduce transportation costs, improve
operational flexibility, shorten customer lead time and lower
inventory carrying costs.
Warehouse types:
Finished goods warehouse

Consolidation warehouse
Break-bulk warehouse
Cross-docking warehouse
68
9/24/2012
Finished goods warehouse

Responsible for the storage of finished goods.
Continuous inflow and outflow of goods.
Goods getting in and out of the warehouse are to be properly
recorded.
Products are to be kept in designated places depending on
physical characteristics, chemical properties, arrival date,
demand pattern, expiry dates etc.
Manufacturing
plant
Finished goods
warehouse
Customer
Consolidation warehouse
Suitable, when supplies come from various sources in small
quantities while the need of the customers happens to be
very high.
Small shipments from all suppliers are combined into a large
shipment in the warehouse.
A single manufacturer may use a consolidation warehouse to
bring together the outputs from several plants.
Vendor 1
Vendor 2
Vendor 3
Buyer 1
Consolidation
Warehouse
Buyer 2
Buyer 3
69
9/24/2012
Break-bulk warehouse
The reverse of the consolidation warehouse.
The bulk incoming shipment from a single supplier is divided
into small shipments for the purpose of delivery to the final
customers.
The bulk cargo of oil, gas, fertilizers etc. coming from a single
source is broken down into small consignments.
Customer 1
Manufacturing
/Processing
Plant
Break-bulk
Warehouse
Customer 2
Customer 3
Cross-docking warehouse
Similar to break-bulk warehouse except that it involves
multiple suppliers.
Different items arriving in bulk from different suppliers in FTL
mode are broken down into smaller shipments in the crossdocking warehouse.
Smaller shipment of each item is loaded into the outbound
truck in FTL mode.
Most commonly used in retail chains.
70

Module 2

Hochgeladen von

Dokumentinformationen

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Module 2

Hochgeladen von

Copyright:

Verfügbare Formate

9/24/2012

Overview on demand planning and forecasting

Forecasting methods: Quantitative

Selection of a particular forecasting tool

Demand planning and forecasting: An

Demand planning and forecasting: An

Different organizations utilize different types of

Random component is that part of the forecast that

Systematic components of forecast

(Source: Shah, 2009, Supply Chain Management, Pearson Education)

Forecasting methods: Qualitative

Forecasting methods: Qualitative

Forecasting methods: Qualitative

Involves eliciting opinions from the potential customers

Forecasting methods: Quantitative

Tries to predict the systematic component of demand.

Forecasting methods: Quantitative

Estimating forecast error

Estimating forecast error

Time Series Forecasting Methods

Time Series Forecasting Methods

Based on the assumption that the estimates of level, trend and

Time Series Forecasting Methods

Time Series Forecasting Methods

Time Series Forecasting Methods

Time Series Forecasting Methods

Time Series Forecasting Methods

The forecast for the month of January, 2011 is 226.33.

(ii) Weighted MA method:

Time Series Forecasting Methods

Time Series Forecasting Methods

The forecast for the month of January, 2011 is 225.85.

(iii) Simple exponential smoothing:

Time Series Forecasting Methods

Time Series Forecasting Methods

Forecast demand for the month of January, 2011 is 203.87

Time Series Forecasting Methods

Time Series Forecasting Methods

is a smoothing constant for the level (0<=<=1) and is a

Time Series Forecasting Methods

Mean error MAD

Forecast for the month of January, 2011 is 211.33.

Time Series Forecasting Methods

is a smoothing constant for level (0<=<=1) and is a smoothing

Time Series Forecasting Methods

Time Series Forecasting Methods

Time Series Forecasting Methods

Forecast for the 1st quarter of the next year is 204.605

Time Series Forecasting Methods

is a smoothing constant for level (0<=<=1), is a

Time Series Forecasting Methods

Time Series Forecasting Methods

Forecast for the first quarter of the next year is 212.3638

Selection of a particular forecasting tool

List of supplier evaluation criteria considered important from the

Quality system at suppliers place/ quality policy /quality philosophy

Case study on vendor evaluation

Identification of supplier evaluation criteria

Major Criteria: C1: Technical factors;

Case Study on vendor evaluation

Performance rating of the suppliers

Factor Scores of the suppliers

Evaluation of suppliers (Contd.)

Performance rating of the suppliers