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Cycle Inventory 2
1
Managing Cycle Inventories
o Each of these factors impact upon the
lot size and cycle inventory in
particular ways.
o There are several managerial levers
that can be employed to reduce cycle
inventory in a supply chain without
raising costs.
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Cycle Inventory Illustrated
o Consider the sale of jeans at a
department store. Demand for jeans
is considered to be fairly stable at
D=100 jeans per day.
n If the store manager purchases in lots of
Q = 1,000 jeans, an inventory profile of
the jeans at the store can be drawn.
n This develops as a cyclical pattern
repeating over time. It can be easily
represented by a graph.
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Cycle Inventory
Interrelationships
o Lot sizes and cycle inventory also
influence the flow time of material
within the supply chain:
n Avg. flow time = Avg. inventory / Avg. flow
rate
o For any supply chain, average flow
rate equals the demand. Therefore,
n Avg. flow time = Avg. inventory / Demand
n Avg. flow time = Q/2D
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3
Cycle Inventory Adds to the Flow
Time
o The larger the cycle inventory, the longer
the lag time between when a product is
produced and when it is sold.
o All else being equal, a lower level of cycle
inventory is always desirable because large
time lags leave a firm vulnerable to
demand changes in the marketplace.
o A lower cycle inventory is also desirable
because it decreases the working capital
requirement for a firm.
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4
Lot-Size Costs Inter-relationships
Set up Cost Holding Cost Total Cost
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
25 50 75 100 125 150 175 200 225 250
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5
Reducing Lot Sizes Without
Increasing Costs
o A key to reducing cycle inventory is the
reduction of lot size.
o A key to reducing lot size without
increasing costs is to reduce the fixed cost
associated with each lot.
o An alternate way of reducing the lot size
and (or) fixed cost is by aggregating lots
across multiple products, customers, or
suppliers.
n When aggregating lots, tailored aggregation is
best, especially if product specific order costs
are large.
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6
Aggregating Multiple Products
in a Single Order
o To effectively reduce the lot size, the
materials manger needs to
understand the source of the fixed
cost.
o In several companies the array of
products sold is divided into families
or groups with each group managed
independently by a separate product
manager.
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7
Optimal Lot Sizes for Independent
Demand versus Aggregated Demand
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8
An Alternate Situation
o Another way to achieve the previous
result is to have a single delivery
coming up from multiple suppliers.
n Allows fixed transportation cost to be
spread across multiple suppliers.
o Or have a single truck delivering to
multiple retailers.
n Allows fixed transportation cost to be
spread across multiple retailers.
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9
Advanced Shipping Notices
(ASN)
o When attempting to reduce lot sizes, it is
important to focus on reducing the handling
costs. Advanced Shipping Notices (ASN) are
files sent electronically by the supplier to the
customer that contain precise records of the
contents of the truck.
o These electronic notices facilitate updating of
inventory records as well as the decision
regarding storage locations, helping to reduce
the fixed cost of receiving. The reduced fixed
cost of receiving makes it optimal to reduce
the lot size ordered, thus reducing cycle
inventory.
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10
Multiple Order Policy for Best Buy
o In the case of Best Buy Computers with
multiple products, the materials manager
may consider three approaches to the lot
sizing decision:
1. Each product manager orders his model
independently.
2. The product managers jointly order every
product in each lot.
3. Product managers order jointly but not every
order contains every product; that is, each lot
contains a selected subset of the products.
This is also called ‘tailored aggregation.’
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11
The ‘Selected Subset’ Approach
1. Identify the most frequently ordered
product, assuming each product is ordered
independently.
2. Identify the frequency with which other
products are included with the most
frequently-ordered product.
3. Having decided the ordering frequency of
each product, recalculate the ordering
frequency of the most-frequently ordered
product.
4. For each product, evaluate an order
frequency of ni = n/mi.
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12
Economies of Scale to Exploit
Quantity Discounts cont.
o In assessing the impact of quantity
discounts on the supply chain, the following
two questions should be answered.
n Given a pricing schedule with quantity discounts,
what is the optimal purchasing decision for a
buyer seeking to maximize profits? How does
this decision impact the supply chain in terms of
lot sizes, cycle inventories, and flow times.
n Under what conditions should a supplier offer
quantity discounts? What are appropriate pricing
schedules that supplier should offer?
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13
Optimal Lot-Sizing Approach
o The solution procedure evaluates the
optimal lot size for each price Ci and
then settles on the lot size that
minimizes the overall cost.
o There are three possible cases for Qi:
1. qi ≤ Qi.≤ qi+1
2. Qi < qi
3. Qi > qi+1
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Optimal Lot-Sizing Approach
o For each ‘i’ the optimal lot size and
the corresponding costs are
evaluated. The solution is to set the
lot size to be the one that minimizes
total annual cost across all ranges i.
n It can be shown that the overall optimal
lot size will always lie within the range
qi ≤ Qi.≤ qi+1. Hence, the case where
Qi < qi or Qi > qi+1 will not be evaluated
any further.
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15
A Commodity Product Example
Vitamin Product Retailer Manufacturer
Unit price/cost $3 $2
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A Key Point
o For commodity products where price
is set by the market, manufacturers
can use lot size based quantity
discounts to achieve coordination in
the supply chain and decrease supply
chain costs.
n Lot size based discounts, however,
increase cycle inventory in the supply
chain.
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