Inventory Management

Part-III

Aggregating Multiple Products

in a Single Order

Cycle inventory is proportional to lot size.

Lot size can be reduced by reducing ordering costs

for a given demand.

Fixed ordering costs can be reduced either directly or

by aggregation

Aggregating
multiple

orders

products

and

deliveries

spreads

ordering

across
costs

across multiple products.

This helps in reducing the lot size for each product

and cycle inventory.

Aggregating Multiple Products

in a Single Order
Illustration:
Best Buy purchases four computer models .
Demand for each of the model is 1000 units per
month. Best Buy incurs a fixed order placement,
transportation and receiving cost of $4000 each
time an order is placed. Each Computer costs Best
Buy $ 500 and it incurs a holding cost of 20 percent.
All four models originate from the same supplier
a.What is the lot size and cycle inventory if all four
models are ordered separately.
b.What is the lot size and cycle inventory if all four
models are aggregated in a single order.
4-3

Aggregating Multiple Products

in a Single Order
a)
For each model, D = 12 x 1000 = 12000, Co (or S) =
4000, C= 500, i (or h) = 20 %, Cc = 500 x .20 = 100
Q* = 980 for each model, cycle inventory for each
model = 980 / 2 = 490
Total Cycle inventory (for all models)= 4 x 490 = 1960

4-4

Aggregating Multiple Products

in a Single Order
b) Since all models originate from same supplier, benefit of
aggregation can be obtained e.g. all orders can arrive in the
same truck
Now we have single order which contains all four models
D = 4 x 12 x 1000 = 48000, Co (or S) = 4000, C= 500, i
(or h) = 20 %, Cc = 500 x .20 = 100
Q* = 1960, Total Cycle inventory (for all models)= 1960/ 2
= 980
Note a single order contains 490 (=1960/4) units of each
model as compared to 980 for each model in previous case.
Thus lot size and cycle inventory and costs are reduced.
4-5

Aggregating Multiple Products

in a Single Order

Aggregation can be achieved by :

Aggregating multiple products from single supplier

Aggregating deliveries from multiple suppliers into a single truck

Aggregating deliveries to multiple retailers into a single truck

e.g. In Wal Mart, typically each supplier sends full truck load to cross docking DC which contains
aggregated delivery destined for multiple retail stores. Each out bound truck contains
products aggregated from several suppliers destined for single store

Thus,
Aggregating replenishment across multiple products, retailers
or suppliers in a single order allows for reduction in lot
size for individual products and thereby cycle inventory &
costs.
This happens because fixed costs including transportation costs
are spread across multiple products, retailers, suppliers

Lot Sizing and Costs with Multiple

Products or Customers Impact of
Aggregation
Combining multiple products in a single order
increases variety
Part of ordering costs i.e. transportation costs are independent
of variety
Other part of ordering costs i.e. receiving and loading costs
increases with variety of products in a single order.
Hence,

S:

Common order cost - Order cost incurred each

time an order is placed, independent of the variety of products

in the order

si:

Product specific order cost - Additional order

cost incurred if product i is included in the order (can be

different for different product)

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation

In general there can be three approaches in ordering

of multiple products
1. Each product manager orders his or her model
independently

Each product is ordered independently

Each product is delivered independently in a separate truck
No aggregation is done
Easy to coordinate
Results in high costs

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation

In general there can be three approaches in ordering of

multiple products- Complete Aggregation
2. The product managers jointly order every product in each lot

Multiple products are ordered jointly

Each order contains all the different products

Multiple product s are delivered jointly in same truck

Disadvantage is low demand products can be aggregated with

high demand products in every order.

However , it is better to order low demand product less

frequently than high demand products.

Easy to administer / coordinate but can result in high costs

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation
3. Product managers order jointly Tailored Aggregation
It is not necessary that every order contains every product
Each lot contains a selected subset of the products
Selective approach
Complex to administer / coordinate but results in low costs

In all the above three approaches to ordering in case of

multiple products , third approach leads to minimum costs.

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation
IllustrationBest Buy sells three models of computers, the Litepro, the
Medpro and the Heavypro. Annual demand for the three
products are 12,000/yr, 1,200/yr and 120/yr respectively.
Each model costs Best Buy $500. A fixed transportation
cost of $4000 is incurred each time an order is delivered.
For each model ordered and delivered on the same truck,
an additional fixed cost of $1000 is incurred for receiving
and storage. Beat Buy incurs a holding cost of 20 percent.
Evaluate lot sizes that Best Buy manager should order Also
evaluate the annual costs of such policy by employing
three approaches to ordering as discussed before.
4-11

Approach 1 : Multiple Products Ordered and

Delivered Independently
Approach 1 : lots for each product are ordered and
delivered independently.
Demand
DL = 12,000/yr, DM = 1,200/yr, DH = 120/yr
Common order cost
S = $4,000
Product-specific order cost
sL = $1,000, sM = $1,000, sH = $1,000
Holding cost
h = 0.2
Unit cost
CL = $500, CM = $500, CH = $500

Multiple Products Ordered and Delivered

Independently
Litepro

Medpro

Heavypro

12,000

1,200

120

$5,000

$5,000

1,095

346

110

548

173

55

$54,772

$17,321

$5,477

Order frequency

11.0/year

3.5/year

1.1/year

Annual ordering
cost

$54,772

$17,321

$5,477

2.4 weeks

7.5 weeks

23.7 weeks

Total annual
cost = $155,140
Annual
cost
$109,544

$34,642

$10,954

Demand per year

Fixed cost/order
Optimal order size
Cycle inventory
Annual holding
cost

Average flow time

$5,000

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation
Approach 2 : Illustration- Lots/Products are
ordered and delivered jointly for all the three
models.
All models are included each time an order is placed.
Evaluate lot sizes and the annual costs of such policy

4-14

Lots Ordered and Delivered Jointly

S* S sL sM sH

Annual order cost S * n

DL hCL DM hCM DH hCH

Annual holding cost

2n
2n
2n
DL hCL DM hCM DH hCH
Total annual cost

S* n
2n
2n
2n
n*

DL hCL DM hCM DH hCH

2S *

n*

k
i1

Di hCi

2S *

Lots / Products Ordered and Delivered Jointly

S* S sA sB sC $7,000 per order

12,000 100 1,200 100 120 100
n*
9.75
2 7,000
Annual order cost = 9.75 x 7,000 = $68,250
Annual ordering
and holding cost = $61,512 + $6,151 + $615 + $68,250
= $136,528

Products Ordered and Delivered Jointly

Litepro

Medpro

Heavypro

Demand per year (D)

12,000

1,200

120

Order frequency (n)

9.75/year

9.75/year

9.75/year

1,230

123

12.3

615

61.5

6.15

$61,512

$6,151

$615

2.67 weeks

2.67 weeks

2.67 weeks

Optimal order size

(D/n)
Cycle inventory
Annual holding cost
Average flow time

Total annual cost = $ 136,528,

Note this approach which utilizes aggregation reduces total
costs by about 12 % (as compared to Approach 1 without any
aggregation)

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation
Approach 3 : Illustration- Lots/Products are
ordered and delivered jointly for a selected subset
of products.
All models are not included each time an order is placed.
Selective in aggregating or combining different products
that are ordered jointly in a single order
Each lot contains only selected product orders with a aim
to minimize costs
Evaluate lot sizes and the annual costs of such policy
4-18

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation
In Approach 3:
It utilizes a heuristic, solution not optimal but close to

it.
First identify the most frequently ordered product
that will be included in every order.
The common order cost is then entirely allocated to
this product
For each of the less frequently ordered products i,
the ordering frequency is determined using only the
product-specific ordering costs Si.
Each product i is included in every mi orders, mi is an
integer which is calculated
4-19

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation
Let product are indexed by i
i varies from 1 to l (total nos. of products are l)
Each product i has:
annual demand of Di ,
product specific order cost of si,
unit cost Ci
Common order cost is S
All n denotes ordering frequency
mi is an integer

4-20

Lots Ordered and Delivered Jointly for a

Selected Subset
Step 1:

Identify the most frequently ordered product

assuming each product is ordered independently

hCi Di
ni
2(S si )

The most frequently ordered product is i* which is included each

time order is placed

Lots Ordered and Delivered Jointly for a

Selected Subset
Step 2:

For all products i i*, evaluate the ordering

frequency

hCi Di
ni
2si

ni

represents the desired order frequency if product i

incurs product specific fixed order cost only each time it
is ordered.
4-22

Lots Ordered and Delivered Jointly for a

Selected Subset
Step 3:

For all i i*, evaluate the frequency of product i

relative to the most frequently ordered product i*
to be mi

mi n/ ni

Goal is to include each product i i* with the most

frequently ordered product after an integer nos. of orders. This

integer no. is denoted by mi
mi is obtained by rounding off to nearest integer
Product i shall be included with most frequently ordered

product i* every mi orders

Note for most frequently ordered product mi = 1
For less frequently ordered product m i

shall be

Lots Ordered and Delivered Jointly for a

Selected Subset
Step 4:

Recalculate the ordering frequency of the most

frequently ordered product i* to be n

l
i1

hCi mi D

2 S si / mi
l

i1

Note now with most frequently ordered product, in

each order, we are also including some other product i.
This shall have impact on holding as well as ordering
costs.
This need to be taken into account for a better
estimate of ordering frequency of most frequently
4-24
ordered product.

Lots Ordered and Delivered Jointly for a

Selected Subset
Step 5:

Evaluate an order frequency of ni = n/mi with n calculated in

Step 4. Also calculate the total cost of such an ordering policy

D
i
TC nS ni si
hC1
i1
i1 2ni
l

The above heuristic results in Tailored aggregation Higher-demand

products ordered more frequently and lower-demand products ordered less
frequently

Ordered and Delivered Jointly Frequency

Varies by Order
Approach 3: Steps 1 to 5 applied to Best Buy problem

Applying Step 1

hCL DL
nL
11.0
2(S sL )

Thus,

n 11.0
nM

hCM DM
3.5
2(S sM )

hCH DH
nL
1.1
2(S sH )

Ordered and Delivered Jointly Frequency

Varies by Order
Applying Step 2

hCM DM
hCH DH
nM
7.7 and nH
2.4
2sM
2sH

Applying Step 3

n
11.0
n
11.0


mM
2 and mH
5
n 7.7
n 2.4
M
H

Ordered and Delivered Jointly

Frequency Varies by Order
Applying Step 4

n 11.47

Applying Step 5

nL 11.47 / yr

nM 11.47 / 2 5.74 / yr

nH 11.47 / 5 2.29 / yr
Annual order cost

Total annual cost

nS nL sL nM sM nH sH $65,383.5

$130,767

Annual Holding Costs = $

65,383.5

Ordered and Delivered Jointly Frequency

Varies by Order
Litepro

Medpro

Heavypro

Demand per year (D)

12,000

1,200

120

Order frequency (n)

11.47/year

5.74/year

2.29/year

1,046

209

52

523

104.5

26

$52,307

$10,461

$2,615

2.27 weeks

4.53 weeks

11.35
weeks

Optimal order size

(D/n)
Cycle inventory
Annual holding cost
Average flow time

Total annual cost = $ 130,767

Note this approach which utilizes tailored aggregation
reduces total costs by about 4 % (as compared to Approach
2 with complete aggregation)

Lot Sizing with Multiple

Products or Customers Impact of
Aggregation
Note:

As discussed before, Approach 1 is no

aggregation, Approach 2 is complete aggregation
and Approach 3 is Tailored Aggregation

If product specific ordering costs are small relative to

common fixed ordering costs, then tailored aggregation

provides little additional value, in this case complete
aggregation is effective.
If product specific ordering costs are high relative to

common fixed ordering costs, then tailored aggregation

provides is effective.
4-30

Aggregation and Capacity Constraint

Optimal Order Frequency when aggregating k nos.

of items is given by:

n*

k
i1

Di hCi

2S *

Truck capacity for a single delivery need to be

compared with total load for the optimal order

frequency.
If optimal load exceeds truck capacity, n* should

be increased until load equals truck capacity

4-31

Managing Multiechelon
Cycle Inventory
Multi-echelon supply chains have multiple stages with
possibly many players at each stage
Lack of coordination in lot sizing decisions across the
supply chain results in high costs and more cycle inventory
than required
The goal is to decrease total costs by coordinating orders
across the supply chain

Managing Multiechelon
Cycle Inventory

Figure 11-6

Integer Replenishment Policy

Divide all parties within a stage into groups such that all
parties within a group order from the same supplier and
have the same reorder interval
Set reorder intervals across stages such that the receipt of
a replenishment order at any stage is synchronized with
the shipment of a replenishment order to at least one of its
customers
For customers with a longer reorder interval than the
supplier, make the customers reorder interval an integer
multiple of the suppliers interval and synchronize
replenishment at the two stages to facilitate cross-docking

Integer Replenishment Policy

For customers with a shorter reorder interval than the

supplier, make the suppliers reorder interval an integer
multiple of the customers interval and synchronize
replenishment at the two stages to facilitate cross-docking
The relative frequency of reordering depends on the setup
cost, holding cost, and demand at different parties
These polices make the most sense for supply chains in
which cycle inventories are large and demand is relatively
predictable

Integer Replenishment Policy

Figure 11-7

Integer Replenishment Policy

Figure 11-8

Managing Safety Inventory in a Multiechelon Supply Chain

In multiechelon supply chains stages often do not know

demand and supply distributions

Inventory between a stage and the final customer is called

the echelon inventory

Reorder points and order-up-to levels at any stage should be

based on echelon inventory

Decisions must be made about the level of safety inventory

carried at different stages