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1
Inventory Management, Supply Contracts
and Risk Pooling
Learning Objectives:
Introduction to Inventory Management.
The Effect of Demand Uncertainty:
Economic Order Quantity
Reorder Points
Service levels
(s,S) Policy
Periodic Review Policy
Supply Contracts
Risk Pooling
Centralized vs. Decentralized Systems.
Practical Issues in Inventory Management.
2
Types of Inventory & the Flow of Materials
S S
Supplier Supplier
B Supplier Supplier
A C D
Work in Process
S
S
Finished Goods
ss
Warehouse X Warehouse Z
Warehouse Y
3
Role of Inventory in Supply Chain
Types of Inventory
WIP
Raw materials
Finished goods
Distribution Inventories
Maintenance, Repair, and Operational Suppliers (MROs)
Transit Inventories
4
Role of Inventory in Supply Chain
5
Role of Inventory in Supply Chain
6
Role of Inventory in Supply Chain
7
Objectives of Inventory Management
8
Understanding Inventory
Demand Characteristics
Replenishment Lead Time
Number of Products
Objectives
Service level
Minimize costs
9
Inventory Cost Structure
Cost Structure:
Order costs
Setup and teardown costs.
Production control costs.
Purchase order costs.
Lost capacity cost.
Holding Costs
Insurance & Security
Warehouse rental, heat & lights
Maintenance and Handling
State and Property Taxes
Opportunity Costs
Losses due to Pilferage, Spoilage, Damage, or
Obsolescence
10
Economic Lot Size Model
11
Economic Lot Size Model
12
1. You receive an order quantity Q. 4. The cycle then repeats.
Number
of units
on hand Q Q Q
R
L L
2. Your start using
them up over time. 3. When you reach down to
Time a level of inventory of R,
R = Reorder point
Q = Economic order quantity you place your next Q
L = Lead time sized order.
13
Cost Minimization Goal
By
Byadding
addingthe
theitem,
item,holding,
holding,andandordering
orderingcosts
costs
together,
together,we
wedetermine
determinethe
thetotal
totalcost
costcurve,
curve,which
whichinin
turn
turnis
isused
usedtotofind
findthe
theQQopt inventory order point that
opt inventory order point that
minimizes
minimizestotal
totalcosts
costs
Total Cost
C
O
S
T Holding
Costs
Annual Cost of
Items (DC)
Ordering Costs
QOPT
Order Quantity (Q)
Basic Fixed-Order Quantity (EOQ) TC=Total
TC=Totalannual
annual
cost
cost
Model Formula
DD=Demand
=Demand
Total Annual Annual Annual CC=Cost
=Costperperunit
unit
Annual = Purchase + Ordering + Holding QQ=Order
=Orderquantity
quantity
Cost Cost Cost Cost SS=Cost
=Costofofplacing
placing
an
anorder
orderororsetup
setup
cost
cost
RR=Reorder
=Reorderpointpoint
LL=Lead
=Leadtime
time
H=Annual
H=Annualholding
holding
D
D Q
Q and
andstorage
storagecost
cost
TC
TC == DC
DC ++ SS++ H H per
perunit
unitof
ofinventory
inventory
Q
Q 22
Deriving the EOQ
Using
Using calculus,
calculus, we
we take
take the
the first
first derivative
derivative of
of
the
the total
total cost
cost function
function with
with respect
respect to
to Q,
Q, and
and
set
set the
the derivative
derivative (slope)
(slope) equal
equal to
to zero,
zero, solving
solving
for
for the
the optimized
optimized (cost
(cost minimized)
minimized) value
value of
of Q
Qopt
opt
2DS
2DS = 2(Annual
2(Annual DDem
em and)(Order
and)(Order oror Setup
Setup Cost)
Cost)
QQOPT =
OPT = HH = Annual
Annual Holding
Holding Cost
Cost
__
We
Wealso
alsoneed
needaa RReorder
eorder point,
point, RR == dd LL
reorder
reorderpoint
pointto
to _
tell
tellus
uswhen
whento
to d = average daily demand (constant)
place
placeananorder
order L = Lead time (constant)
EOQ Example (1) Problem Data
Given
Given the
theinformation
information below,
below,what
what are
arethe
theEOQ
EOQand
and
reorder
reorder point?
point?
1,000
1,000 units
units // year
year = 2.74 units / day
dd == = 2.74 units / day
365 days / year
365 days / year
__
Reorder
Reorderpoint,
point, RR == dd LL== 2.74units
2.74units//day
day(7days)
(7days)==19.18
19.18 or
or 20
20 units
units
In
Insummary,
summary,youyouplace
placeananoptimal
optimalorder
orderof
of90
90units.
units. In
In
the
thecourse
courseof
ofusing
usingthe
theunits
unitsto
tomeet
meetdemand,
demand,when
when
you
youonly
onlyhave
have2020units
unitsleft,
left,place
placethe
thenext
nextorder
orderof
of9090
units.
units.
EOQ Example (2) Problem Data
Determine
Determine thethe economic
economic order
order quantity
quantity
and
and the
the reorder
reorder point
point given
given the
the following…
following…
10,000
10,000 units
units// year
year = 27.397 units / day
dd == = 27.397 units / day
365 days / year
365 days / year
__
RR == dd LL== 27.397
27.397 units
units//day
day (10
(10 days)
days)== 273.97
273.97 or
or 274
274 units
units
Place
Placean
anorder
orderfor
for366
366units.
units. When
Whenin inthe
thecourse
courseofof
using
usingthe
theinventory
inventoryyou
youare
are left
left with
withonly
only274
274units,
units,
place
placethe
thenext
next order
orderofof366
366units.
units.
EOQ: Optimal Order Quantity
Example:
Suppose that an annual demand for an outdoor
carpet is 20,000yds. The cost of placing an order is
estimated at $50 per order, whereas the carrying
cost rate per year is 20% and the item cost is $10.
How many yards of outdoor carpet should be
stocked?
D=20,000yds
s=$50
i=0.20
c=10
21
EOQ Model: An Example
EOQ = Q* = 25020000/(0.2010)
= 1000 yds.
22
EOQ Model: An Example
23
EOQ Model: An Example
24
The Effect of
Demand Uncertainty
25
Demand Forecast
26
SnowTime Sporting Goods
27
Supply Chain Time Lines
28
SnowTime Demand Scenarios
Demand Scenarios
P ro b a b ilit y
30%
25%
20%
15%
10%
5%
0%
Sales
29
SnowTime Costs
Profit =
Revenue - Variable Cost - Fixed Cost + Salvage
30
SnowTime Scenarios
Scenario One:
Suppose you make 12,000 jackets and demand
ends up being 13,000 jackets.
Profit = 125(12,000) - 80(12,000) - 100,000 =
$440,000
Scenario Two:
Suppose you make 12,000 jackets and demand
ends up being 11,000 jackets.
Profit = 125(11,000) - 80(12,000) - 100,000 +
20(1000) = $ 335,000
31
SnowTime Best Solution
32
What to Make?
33
SnowTime Expected Profit
Expected Profit
$400,000
$300,000
Profit
$200,000
$100,000
$0
8000 12000 16000 20000
Order Quantity
34
SnowTime Expected Profit
Expected Profit
$400,000
$300,000
Profit
$200,000
$100,000
$0
8000 12000 16000 20000
Order Quantity
35
SnowTime: Important Observations
36
Key Insights From This Model
37
Supply Contracts
38
Supply Contracts
Selling Price=$125
Salvage Value=$20
Stores
39
Demand Scenarios
Demand Scenarios
30%
Probability
25%
20%
15%
10%
5%
0%
Sales
40
Retailer Expected Profit
Expected Profit
500000
400000
300000
200000
100000
0
6000 8000 10000 12000 14000 16000 18000 20000
Order Quantity
41
Retailer Expected Profit
Expected Profit
500000
400000
300000
200000
100000
0
6000 8000 10000 12000 14000 16000 18000 20000
Order Quantity
42
Supply Contracts (Cont.)
43
Supply Contracts (Cont’d)
44
Supply Contracts
Selling Price=$125
Salvage Value=$20
Stores
45
Retailer Profit Buy Back=$55)
Buy-Back Contracts:
Suppose the manufacturer offers to buy back
unsold jackets from the retailer for $55.
46
Retailer Profit Buy Back=$55)
600,000
500,000
Retailer Profit
400,000
300,000
200,000
100,000
Order Quantity
47
Retailer Profit (Buy Back=$55)
600,000
$513,800
500,000
Retailer Profit
400,000
300,000
200,000
100,000
0
00
00
00
00
0
00
00
00
00
00
00
00
00
00
60
80
70
90
11
13
14
16
18
10
12
15
17
Order Quantity
48
Manufacturer Profit (Buy Back=$55)
600,000
Manufacturer Profit
500,000
400,000
300,000
200,000
100,000
0
Production Quantity
49
Manufacturer Profit (Buy Back=$55)
600,000
$471,900
Manufacturer Profit
500,000
400,000
300,000
200,000
100,000
Production Quantity
50
Buy-Back SC Profit (Buy back = 55)
51
Supply Contracts (Cont’d)
Revenue-Sharing Contracts:
In revenue-sharing contracts, buyer shares some
of its revenue with the seller, in turn for a discount
on the wholesale price.
52
Supply Contracts
Selling Price=$125
Salvage Value=$20
Stores
53
Retailer Profit (Wholesale Price $60, RS
15%)
600,000
500,000
Retailer Profit
400,000
300,000
200,000
100,000
0
Order Quantity
54
Retailer Profit (Wholesale Price $60, RS
15%)
600,000
$504,325
500,000
Retailer Profit
400,000
300,000
200,000
100,000
0
Order Quantity
55
Manufacturer Profit (Wholesale Price $60,
RS 15%)
700,000
Manufacturer Profit
600,000
500,000
400,000
300,000
200,000
100,000
0
Production Quantity
56
Manufacturer Profit (Wholesale Price $60,
RS 15%)
700,000
Manufacturer Profit
600,000
500,000 $481,375
400,000
300,000
200,000
100,000
0
Production Quantity
57
Revenue-Sharing SC Profit (Wholesale Price
$60, RS 15%)
58
Supply Contracts
59
Supply Contracts (Cont’d)
Global Optimization:
Both the manufacturer and the retailer are
considered as two members of the same
organization, causing the transfer of money
between the two parties is ignored.
60
Supply Contracts
Selling Price=$125
Salvage Value=$20
Stores
61
Supply Chain Profit
1,200,000
S upply Cha in P rofit
1,000,000
800,000
600,000
400,000
200,000
0
Production Quantity
62
Supply Chain Profit
1,200,000
$1,014,500
Supply Chain Profit
1,000,000
800,000
600,000
400,000
200,000
0
Production Quantity
63
Supply Contracts
64
Supply Contracts: Key Insights
65
Supply Contracts: Case Study
66
Supply Contracts: Case Study
67
Other Contracts
68
SnowTime Costs: Initial Inventory
Profit =
Revenue - Variable Cost - Fixed Cost + Salvage
69
SnowTime Expected Profit
Expected Profit
$400,000
$300,000
Profit
$200,000
$100,000
$0
8000 12000 16000 20000
Order Quantity
70
Initial Inventory
71
(s, S) Policies
72
Risk Pooling
Market One
Supplier Warehouse
Market Two
73
Risk Pooling
74
Risk Pooling:
Important Observations
75
Risk Pooling:
Types of Risk Pooling
Orders
10 11 12 13 14 15
Demands 76
To Centralize Or Not To Centralize
Service level?
Overhead?
Lead time?
Transportation Costs?
77
Centralized Systems
Centralized Decision:
Supplier
Warehouse
Retailers
78
Factors that Drive Reduction in Inventory
79
Factors that Drive Inventory Turns
Increase
Better software for inventory management
(16.2%).
Reduced lead time (15%).
Improved forecasting (10.7%).
Application of SCM principles (9.6%).
More attention to inventory management (6.6%).
Reduction in SKU (5.1%).
Others.
80
End of the Session
Thank You
81