VALUE ADDED LOGISTICS

BASIC FORMS OF VAL

Three basic forms of VAL:

Value added Value added

shipment servicing

Value added
transformation
 BASIC FORMS OF VAL

Value added shipment – VAS

 VAS: basic service in the actual distribution branch

• Packaging and Re- packing

• Labeling, marking

• Reconditioning

• Assembling display or kits with several products

• Controlling
Value added servicing
 Technical quality control

 Sampling

 Testing

 Activities related to customer service such as

customer satisfaction survey
Value added transformation - VAT
 End-assembly

 Distribution function

• De-consol

• Re-consol
 DEBIT OF WAREHOUSE CHARGES/RENT
ACTIVITY BASED COSTING
 Main factors in warehousing cost:

• Lease or capital costs + operational costs of buildings and equipment

• Direct labor costs for handling, administration

• Indirect costs of management, overhead and systems

$/pallet = total annual cost / total annual pallet qty flowing through
warehouse

ABC is a way of attributing costs, calculated on the basis of actual costs

per transaction
Warehouse Costs

Fixed Variable
• Public 1 5
• Leased 2 4
• Private - Manual handling 3 3
• Private - Pallet/Forklift 4 2
• Private - Automated 5 1

• 1 = lowest cost
Warehouse Costs

l in g
ic a nd
b l
u a lh
Pu -M
a n
te
va
Pri t ed
A u t o ma
Private -
Total Cost

cwt Handled
Warehouse Costs

ua l
lic an
b e -M
Pu va t
Pri dling
han
- Au t o mated
Private
Total Cost

Use Private -
Use Private - Automated
Manual handling
Use cwt Handled
Public
 DEBIT OF WAREHOUSE CHARGES/RENT
WAREHOUSE TARIFFS

 Warehouse Rent (Storage Tariff)

 Warehouse Handling Fees and Ancillary Charges

Warehouse Rent (Storage Tariff)

 $/ m2 / day

• (the lease or capital costs + operational costs of building and

equipment)/ square meter * number of days

 $/pallet / day

• (the lease or capital costs + operational costs of building and

equipment)/ pallet locations * number of days
Warehouse Handling Fees & Ancillary Charges

• WH Handling Fee: $ / man-hour; including a surcharge for indirect costs

• For example: management costs could be divided based on the estimated

% of management attention
• Tariff / user to be calculated per time expense

• Ancillary charges to be calculated for VAL- activities

 Inventory costs
• Purchasing costs
– material cost, unit cost
Purchase
• Ordering costs option
– fixed cost of preparing and monitoring order
– receiving and handling
• Production cost
– material and variable manufacturing cost Production
• Set-up cost option
– fixed cost to prepare for manufacture
• Holding costs
– opportunity cost
– storage and handling costs
– taxes and insurance
– pilferage, damage, spoilage, obsolescence, etc.
• Backorder and lost sales costs
Inventory Calculations

• Inventory Carrying Cost

= Dollar value of inventory x percentage carrying cost

• Example
If dollar value of inv. = $50,00
And carrying cost = 22% of product value
Then Inventory Carrying Cost
=
=
Inventory Calculations

• Inventory Carrying Cost

= Dollar value of inventory x percentage carrying cost

• Example
If dollar value of inv. = $50,00
And carrying cost = 22% of product value
Then Inventory Carrying Cost
= ( 50 ) ( .22 )
= $ 11.00 per year
 Sales
• Inventory Turnover =
Average Inventory
• Example: K-Mart
1992 Sales = $38.8 billion
1992 Avg. Inv. = $8.8 billion
$38.8 billion
Inventory Turnover =
$8.8 billion

= turns/year
 Sales
• Inventory Turnover =
Average Inventory
• Example: K-Mart
1992 Sales = $38.8 billion
1992 Avg. Inv. = $8.8 billion
$38.8 billion
Inventory Turnover =
$8.8 billion

= 4.41 turns/year
• Average Day’s
Avg. Inv.
Inventory on Hand = x 365
Sales

• Example: K-Mart (cont.)

1992 Sales = $38.8 billion
1992 Avg. Inv. = $8.8 billion
$8.8
Avg. Day’s IOH = x 365
$38.8

= Days
• Average Day’s Avg. Inv.
= x 365
Sales
Inventory on Hand
• Example: K-Mart (cont.)

1992 Sales = $38.8 billion

1992 Avg. Inv. = $8.8 billion
Avg. Day’s IOH = $8.8
x 365
$38.8
= 82.8 Days
 EOQ - Economic Order Quantity

• Basically, EOQ system helps you identify the most economical way to
replenish your inventory by showing you the best order quantity.
• EOQ is the order size that "minimizes" Total Costs.
• Behavior of Economic Order Quantity (EOQ) Systems
• Determining Order Quantities
• Determining Order Points
THE EOQ MODEL

Demand
Order qty, Q rate
Inventory Level

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
Placed Received Placed Received
Behavior of EOQ Systems

• As demand for the inventoried item occurs, the inventory level drops.
• When the inventory level drops to a critical point, the order point, the
ordering process is triggered.
• The amount ordered each time an order is placed is fixed or constant.
• When the ordered quantity is received, the inventory level increases.
• An application of this type system is the two-bin system.
• A perpetual inventory accounting system is usually associated with
this type of system.
Determining Order Quantities

• Basic EOQ
• EOQ for Production Lots
Basic EOQ

Typical assumptions made

– Only one product is involved.
– Annual demand requirements 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.
EOQ: A View of Inventory*
Note:
• No Stockouts
• Order when no inventory
• Order Size determines policy

Inventory

Order
Size

Avg. Inven

Time
Assumptions

• Demand occurs at a uniform rate

• Do inventory when an order arrives
• Stock-out, customer responsiveness, and other costs are inconsequential.
• Acquisition cost is fixed, i.e., no quantity discounts
Assumptions

–Annual demand (D), carrying cost (C) and ordering cost (S) can be
estimated.
–Average inventory level is the fixed order quantity (Q) divided by 2
which implies
• no safety stock
• orders are received all at once
EOQ = mathematical device for arriving at the purchase quantity of an item that will
minimize the cost. - Set (Q/2)H = (D/Q)S and solve for Q
Total cost = holding costs + ordering costs
Ordering Cost = average number of orders per year x ordering cost per order = (D/Q)S
Carrying Cost = average inventory x carrying cost per unit = (Q/2)C
Definition of EOQ Components

H = annual holding cost for one unit of inventory

S = cost of placing an order, regardless of size
P = price per unit
d = demand per period
D = annual demand
L = lead time
Q = Order quantity (this is what we are solving for)
EOQ: Calculating Total Cost*

Annual Annual
Total cost = carrying + ordering
cost cost

Q D
TC = H + S
2 Q
EOQ Cost Model

• D - annual demand
• Q - order quantity
• S - cost of placing order
• H - annual per-unit holding cost
• Ordering cost = SD/Q
• Holding cost = HQ/2
• Total annual stocking cost (TSC) = annual carrying cost +
annual ordering cost = (Q/2)C + (D/Q)S
• The order quantity where the TSC is at a minimum (EOQ)
can be found using calculus (take the first derivative, set it
equal to zero and solve for Q)
Solve for Q algebraically
• (Q/2)H = (D/Q)S
2 DS
Q *

• Q2 = 2DS/H H

• Q = square root of (2DS/H) = EOQ

2DS 2(Annual Demand)(O rder or Setup Cost)

QOPT = =
H Annual Holding Cost
 The EOQ Model Cost Curves

Slope = 0
Annual Total Cost
cost ($)
Minimum
total cost
Holding Cost = HQ/2

Ordering Cost = SD/Q

Optimal order Q* Order Quantity, Q

EOQ:Total Cost*

160
140
120 Total Cost
100
C ost

Holding Cost
80
60
40 Order Cost
20
0
0 500 1000 1500
Order Quantity
Cost Minimization Goal

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
2 Q
Annual Cost

Holding Costs

Ordering Costs

(optimal order quantity)

Order Quantity (Q)
Minimum Total Cost
The total cost curve reaches its minimum where the carrying and ordering costs are equal.

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
2 Q
Annual Cost

Holding Costs

Ordering Costs

(optimal order quantity)

Order Quantity (Q)
Example: Basic EOQ

• Z-Company produces fertilizer to sell to wholesalers. One raw

material: calcium nitrate is purchased from a nearby supplier at
$22.50 per ton. Z-Company estimates it will need 5,750,000 tons of
calcium nitrate next year.
• The annual carrying cost for this material is 40% of the acquisition

cost, and the ordering cost is $595.

Example: Basic EOQ

a) What is the most economical order quantity?

b) How many orders will be placed per year?

c) How much time will elapse between orders?

Remember
• H = annual holding cost for one unit of inventory
• S = cost of placing an order, regardless of size
• P = price per unit
• d = demand per period
• D = annual demand
• L = lead time
• Q = Order quantity (this is what we are solving for)
Example: Basic EOQ
• Economical Order Quantity (EOQ)
D = 5,750,000 tons/year
C = .40(22.50) = $9.00/ton/year
S = $595/order
EOQ = 2DS/C
EOQ = 2(5,750,000)(595)/9.00
Q= 27,573.135 tons per order

40
Example: Basic EOQ

• Total Annual Stocking Cost (TSC)

TSC = (Q/2)C + (D/Q)S
= (27,573.135/2)(9.00)
+ (5,750,000/27,573.135)(595)
= 124,079.11 + 124,079.11
= $248,158.22
Note: Total Carrying Cost
equals Total Ordering Cost
Basic EOQ
• Number of Orders Per Year
= D/Q
= 5,750,000/27,573.135
= 208.5 orders/year

• Time Between Orders

= Q/D Note: This is the inverse
= 1/208.5 of the formula above.
= .004796 years/order
= .004796(365 days/year) = 1.75 days/order
Assignment

The I-75 Carpet Discount Store in North Georgia stocks carpet in its
warehouse and sells it through an adjoining showroom. The store
keeps several brands and styles of carpet in stock; however, its
biggest seller is Super Shag carpet. The store wants to determine the
optimal order size and total inventory cost for this brand of carpet
given an estimated annual demand of 10,000 yards of carpet, an
annual carrying cost of $0.75 per yard, and an ordering cost of $150.
The store would also like to know the number of orders that will be
made annually and the time between orders (i.e., the order cycle)
given that the store is open every day except Sunday, Thanksgiving
Day, and Christmas Day (which is not on a Sunday).

http://www.prenhall.com/divisions/bp/app/russellcd/PROTECT/CHAPTERS/CHAP12/HEAD03.HTM
 EOQ for Production Lots

• Used to determine the order size, production lot.

• Differs from Model I because orders are assumed to be supplied or

produced at a uniform rate (p) rather than the order being received
all at once.
• It is also assumed that the supply rate, p, is greater than the
demand rate, d
• The change in maximum inventory level requires modification of
the TSC equation
• TSC = (Q/2)[(p-d)/p]C + (D/Q)S
• The optimization results in

2DS  p 
EOQ =
C  p  d 
Example: EOQ for Production Lots

Electric Company buys coal from Coal Company to generate

electricity. The seller company can supply coal at the rate of 3,500
tons per day for $10.50 per ton. The buyer company uses the coal at a
rate of 800 tons per day and operates 365 days per year.
Example: EOQ for Production Lots

•The buyer company’s annual carrying cost for coal is 20% of the
acquisition cost, and the ordering cost is $5,000.
a)What is the economical production lot size?
b) What is The buyer company ’s maximum inventory level for coal?
Example: EOQ for Production Lots

Economical Production Lot Size

D(demand)= 800 tons/day; D = 365(800)=292,000tons/year
P(supply) = 3,500 tons/day for $10.50 per ton
S(ordering cost)=$5,000/order.;
C(carrying cost)=0.20(10.50)=$2.10/ton/year
EOQ = (2DS/C)[p/(p-d)]
EOQ = 2(292,000)(5,000)/2.10[3,500/(3,500-800)]
= 42,455.5 tons per order
Example: EOQ for Production Lots

• Total Annual Stocking Cost (TSC)

TSC = (Q/2)((p-d)/p)C + (D/Q)S
= (42,455.5/2)((3,500-800)/3,500)(2.10)
+ (292,000/42,455.5)(5,000)
= 34,388.95 + 34,388.95
= $68,777.90 Note: Total Carrying Cost
equals Total Ordering Cost
 Assignment
Assume that the I-75 Outlet Store has its own manufacturing
facility in which it produces Super Shag carpet. The ordering
cost, Co, is the cost of setting up the production process to make
Super Shag carpet. Recall Cc = $0.75 per yard and D = 10,000
yards per year. The manufacturing facility operates the same
days the store is open (i.e., 311 days) and produces 150 yards
of the carpet per day. Determine the optimal order size, total
inventory cost, the length of time to receive an order, the number
of orders per year, and the maximum inventory level.
 When to Reorder with EOQ Ordering

• Reorder Point - When the quantity on hand of an item drops to

this amount, the item is reordered.
• Safety Stock - Stock that is held in excess of expected demand
due to variable demand rate and/or lead time.
• Service Level - Probability that demand will not exceed supply
during lead time.
Reorder Point
inventory

slope = -D

L time

R = lead-time demand = LD – mQ*

where m = integer [L / T*]
• Reorder Point (ROP)
= minimum amount of inventory to last during the replenishment or lead time
= [Lead time length (in days)] X [Demand per day (in units per day)]

• Reorder Point (ROP) calculations:

ROP = DD x RC under certainty

ROP = (DD x RC) + SS under uncertainty
Where DD = daily demand
RC = length of replenishment cycle
SS = safety stock
Determinants of the Reorder Point
• The rate of demand

• The lead time

• Demand and/or lead time variability

• Stock-out risk (safety stock)

 Inventory Model Under
Conditions of Uncertainty
• EOQ is still the amount ordered each time
• Assumes that over time, uncertainty periods balance out

Inventory Level
(Units)

Qm
ROP

Safety
Stock

Time
 Safety Stock

Quantity

Maximum probable demand

during lead time
Expected demand
during lead time

ROP

Safety stock
LT Time
Safety stock reduces risk of
Stock-out during lead time
Trade-Off with Safety Stock
• Safety Stock - Stock held in excess of expected demand to protect
against stockout during lead time.

Safety stock  Holding cost  Stockouts 

Safety stock  Holding cost  Stockouts 

• Safety stock can prevent against two problem areas

– Increased rate of demand
– Longer-than-normal replenishment
• When fixed order quantity system like EOQ is used, time between
orders may vary
• When reorder point is reached, fixed order quantity is ordered
Inventory Flows