Risk Pooling

Consider these two systems:

Warehouse One
Supplier Warehouse Two Market Two Market One

Market One Supplier Warehouse Market Two

Risk Pooling
For the same service level, which system will require more inventory? Why? For the same total inventory level, which system will have better service? Why?

What are the factors that affect these answers?

Risk Pooling Case

Compare the two systems:
two products maintain 97% service level Rs 60 order cost Rs 0.27 weekly holding cost Rs1.05 transportation cost per unit in decentralized system, Rs1.10 in centralized system 1 week lead time

Risk Pooling Case

DEPOT X X Y Y PRODUCT A B A B 1 33 0 46 2 DEMAND PER WEEK 2 3 4 5 6 7 45 37 38 55 30 18 2 3 0 0 1 3 35 41 40 26 48 18 4 0 0 3 1 0

8 58 0 55 0

RISK POOLING
SERVICE LEVEL 97% : DEPOT PRODUCT X X Y Y TOTAL A B A B A B 1 33 0 46 2 79 2 DEMAND PER WEEK 2 3 4 5 6 7 45 37 38 55 30 18 2 3 0 0 1 3 35 41 40 26 48 18 4 0 0 3 1 0 80 78 78 81 78 36 6 3 0 3 2 3 AVG 8 DEMAND 58 39 0 1 55 39 0 1 113 78 0 2 SD CV 13.18 1.36 12.05 1.58 20.71 1.92 0.34 1.21 0.31 1.26 0.27 0.81 1.88 Q BUFFER RP AVG INV 132 22 131 24 186 32 25 3 23 3 39 4 64 4 61 4 117 6 91 14 88 15 132 20

179 26.27 28 30.29

Risk Pooling: Important Observations

Centralizing inventory control reduces both safety stock and average inventory level for the same service level. This works best for
High coefficient of variation, which increases required safety stock. Negatively correlated demand. Why?

Risk Pooling: Types of Risk Pooling*

Risk Pooling Across Markets Risk Pooling Across Products Risk Pooling Across Time Daily order up to quantity is:
LTAVG + z SD LT

Orders

10

11

12

13

14

15

Demands

Changes In Inventory Turnover

Inventory turnover ratio = annual sales/avg. inventory level Inventory turns increased by 30% from 1995 to 1998 Inventory turns increased by 27% from 1998 to 2000 Overall the increase is from 8.0 turns per year to over 13 per year over a five year period ending in year 2000.

Inventory Turnover Ratio

Industry
Dairy Products Electronic Component Electronic Computers Books: publishing Household audio & video equipment Household electrical appliances Industrial chemical

Upper Quartile 34.4 9.8 9.4 9.8 6.2 8.0 10.3

Median 19.3 5.7 5.3 2.4 3.4 5.0 6.6

Lower Quartile 9.2 3.7 3.5 1.3 2.3 3.8 4.4

Factors that Drive Reduction in Inventory

Top management emphasis on inventory reduction (19%) Reduce the Number of SKUs in the warehouse (10%) Improved forecasting (7%) Use of sophisticated inventory management software (6%) Coordination among supply chain members (6%) Others

Factors that Drive Inventory Turns Increase

Better software for inventory management (16.2%) Reduced lead time (15%) Improved forecasting (10.7%) Application of SCM principals (9.6%) More attention to inventory management (6.6%) Reduction in SKU (5.1%) Others