A Project presentation on

Submitted To – Dr. Rupesh Kumar

Submitted By – Nitin Rajput

Course – MBA(LSCM)
Sem- 3rd semester
SAP ID- 500066201
Subject- Supply Chain Analytics
 The Probabilistic inventory model is closely aligned to the manufacturing and retail
reality that from time to time, demand will vary. Demand variations cause shortages,
particularly during lead time if a retailer only has a limited amount of inventory stock to
cover the demand during the lead time when replenishment stock has not arrived.
 The major difference between deterministic and probabilistic inventory model is the
demand and lead time is variable in probabilistic model while in deterministic it is
constant.
 The probabilistic inventory model incorporates demand variation and lead time
uncertainty based on three possibilities:
a. The first is when lead time demand is constant but the lead time itself varies
b. The second is when lead time is constant but demand fluctuates during lead time.
c. The third possibility is when both lead time and demand during lead time vary.
 Probabilistic inventory models consisting of probabilistic supply and demand are
more suitable in most circumstances.
 Two methods are used based on the frequency of order placement for procuring
inventory stock:-
a) single period inventory system
b) multi-period inventory systems.
 The term single period term refers to the situation where the inventory stock is
perishable, and orders are typically only made once. Generally, for one time ordering
of seasonal products or where demand exists only for the period in which it is ordered.
For example, a newspaper sold today will not be sold at the same price tomorrow nor will
summer clothing items be likely to sell during the winter season.
 In a multi-period model, all the items unsold at the end of one period are available in
the next period. With the multi-period method orders are placed multiple times over an
entire production cycle and are further classified as continuous review or periodic review
inventory.
 Continuous review inventory is reviewed constantly and when inventory stock drops to a
certain predetermined par or reorder level, a fixed quantity is ordered. Continuous
review is commonly used for high volume, valuable or important stock items.
 Periodic review inventory is examined at periodic intervals in predetermined
timeframes, irrespective of the levels to which inventory levels drop. At this time an order
is then placed to bring inventory up to the maximum level, the method is largely used for
moderate volume items.
 Loss resulting from the items unsold
(over stocking cost) C1= Purchase price - Salvage value

 Profit resulting from the items sold

(Under stocking cost) C2= Selling price - Purchase price

 Trade-off
Given costs of overestimating/underestimating demand and the probabilities of various
demand sizes how many units will be ordered?
 Consider an order quantity Q
 Let P = probability of selling all the Q units
where, probability (demandQ)

 Then, (1-P) = probability of not selling all the Q units

 Step1. From the data prepare a table showing p(D), probability and the cumulative
probability P(D<Q) for each reasonable value of D.
 Step2. Compute the ratio C2/C1+C2 which is known as service level.
 Step3. Find the value of Q which satisfies the inequality.
EXAMPLE- 1
 A trader stocks a particular seasonal product at the beginning of the season and
cannot re-order. The item costs him Rs. 25 each and he sells at Rs. 50 each. For any
item that cannot be met on demand, the trader has estimated a goodwill cost of
Rs.15. Any item unsold will have a salvage value of Rs. 10. Holding cost during the
period is estimated to be 10 per cent of the price. The probability distribution of
demand is as follows:

Determine the optimal number of items to be stocked.

 Solution:-
As per step 1, we put the data regarding demand distribution in the Table 1 below:

 This ratio lies between cumulative probabilities of 0.60 and 0.80 which in turn reflect `the
values of Q as 3 and 4. That is,
 P(D< 3)=0.60<0.69<0.80 = P(D < 4).
 Therefore, the optimal number of units to stock is 4 units.
 Sample computation for order quantity 4 units
 Expected no. sold = (2*0.35)+(3*0.25)+(4*0.20)= 2.25
 Revenue from sold items= 2.25*S.P = 2.25*50= 112.5Rs.
 Revenue from unsold items= (4-2.25)salvage value
 = 1.75*10= 17.5 Rs.
 Total Revenue= 112.5+17.5= 130 Rs.
 Cost= 4*25= 100 Rs.
 Profit= 130- 100 = 30 Rs.
 Example 2

 A newspaper boy buys papers for Rs. 0.35 each and sells them for Rs. 0.60 each. He can not return
unsold newspapers. Daily demand has the following distribution:

 If each day's demand is independent of the previous day's demand, how many papers should he
order each day?
 Solution

gives Q*=280. Thus, newspaper boy should buy 280 papers each day.
 In single period models, only demand is the major variable factor and lead time
does not play any role in the decision process. But, in multi-period models, both
demand and lead time play major role in the decision process.
 We cushion the effects of demand and lead time variation by absorbing risks in
carrying larger inventories, called buffer stocks or safety stocks. The larger we
make these safety stocks, the greater our risk.
 . Therefore, our objective is to find a rational decision model for balancing these
risks.
  Example-3
A company is ordering an item 4 times a year and has specified a service level of
one stock-out per 3 years. The history of re-order lead times is shown below.
Daily demand of the item is 40 units. Find the re-order level.

Where,
U = random variable representing demand during lead time
 = standard deviation of demand during lead time
U = Expected lead time demand
tL = lead time
d = average daily demand
σd = standard deviation of daily demand
D = expected annual demand
B = buffer stock or safety stock
Z = number of standard deviations needed for a specified confidence level
R = Re-order level
 Example 4- Consider example 3 a case of constant demand and variable lead time.
Find total inventory.

 Solution. For this example, review period is fixed as

 T = ¼ years = 90 days
 Then, average demand during review period is = 90*40= 3600 units
 Average lead time (tL) = 14.83 days
 Therefore, average demand during average lead time = 40x 14.83 = 593.3 units
Variance of lead time = 34.97 (days)2
 Safety stock for confidence level of 91.7 % confidence = 1.39
 Square root of 34.97 = 351.47 units.
 Therefore, the target inventory level
 TI = 3600+593.3+351.4 = 4544.7 or 4545 units.