Managing Facilitating Goods

Replenishment order Replenishment Replenishment order order Customer order Factory Production Delay Wholesaler Distributor Retailer Customer

Shipping Delay Wholesaler Inventory

Shipping Delay Distributor Inventory

Item Withdrawn

Retailer Inventory

Learning Objectives
Discuss the role of information technology in managing inventories. Describe the functions and costs of an inventory system. Determine the order quantity. Determine the reorder point and safety stock for inventory systems with uncertain demand. Design a continuous or periodic review inventory-control system. Conduct an ABC analysis of inventory items. Determine the order quantity for the single-period inventory case. Describe the rationale behind the retail discounting model.

Role of Inventory in Services

Decoupling inventories Seasonal inventories Speculative inventories Cyclical inventories In-transit inventories Safety stocks

Considerations in Inventory Systems

Type of customer demand Planning time horizon Replenishment lead time Constraints and relevant costs

Relevant Inventory Costs

Ordering costs Receiving and inspections costs Holding or carrying costs Shortage costs

Inventory Management Questions

What should be the order quantity (Q)? When should an order be placed, called a reorder point (ROP)? How much safety stock (SS) should be maintained?

Inventory Models
Economic Order Quantity (EOQ) Special Inventory Models With Quantity Discounts Planned Shortages Demand Uncertainty - Safety Stocks Inventory Control Systems Continuous-Review (Q,r) Periodic-Review (order-up-to) Single Period Inventory Model

Inventory Levels For EOQ Model

Units on Hand

0 Q D Time

Annual Costs For EOQ Model

900 800 An nual Cost, $ 700 600 500 400 300 200 100 0 0 100 120 140 20 40 60 80 Holding Cost Ordering Cost Total Cost

Order Quantity, Q

EOQ Formula
Notation D = demand in units per year H = holding cost in dollars/unit/year S = cost of placing an order in dollars Q = order quantity in units Total Annual Cost for Purchase Lots

TCp ! S ( D / Q)  H (Q / 2)
EOQ

EOQ !

2 DS H

Annual Costs for Quantity Discount Model

22,000 C = $20.00 21000 C = $19.50 C = $18.75

20000

2000

1000

100

200

300

400

500

600

700

Order quantity, Q

Inventory Levels For Planned Shortages Model

Q-K

Q 0 TIME

-K T1 T T2

Formulas for Special Models

Quantity Discount Total Cost Model
TCqd ! CD  S ( D / Q)  I (CQ / 2)
D (Q  K ) 2 K2 TCb ! S  H B 2Q 2Q Q
Q !
*

Model with Planned Shortages

2 DS H  B H B
*

H K !Q H  B
*

Values for Q* and K* as A Function of Backorder Cost

B Q* K* 0 Inventory Levels

Bp g

2DS H
2DS H  B H B

H Q* H  B

Bp0

undefined

Q*

Demand During Lead Time Example

WL ! 3
W ! 15 .

W ! 15 .

W ! 15 .
+ +

W ! 15 .

u=3

u=3

u=3

u=3

d L ! 12
ss

ROP

Four Days Lead Time

Demand During Lead time

Safety Stock (SS)

Demand During Lead Time (LT) has Normal Distribution with - Mean(d L ) ! Q ( LT ) - Std . Dev.(W L ) ! W LT SS with r% service level SS ! zrW LT Reorder Point

ROP ! SS  d L

Continuous Review System (Q,r)

Amount used during first lead time Inventory on hand EOQ Reorder point, ROP

Average lead time usage, dL

d3 d1 d2 EOQ

Safety stock, SS

First lead time, LT1

LT2

LT3

Time Order 1 placed Order 2 placed Order 3 placed Shipment 3 received

Shipment 1 received

Shipment 2 received

Periodic Review System (order-up-to)

Inventory on Hand Review period Target inventory level, TIL

RP

RP

RP

First order quantity, Q1

Q2

Q3

Amount used during first lead time

d1

d3

d2

Safety stock, SS

First lead time, LT1

LT2

LT3 Time

Order 1 placed

Order 2 placed

Order 3 placed

Shipment 1 received

Shipment 2 received Shipment 3 received

Inventory Control Systems

Continuous Review System
2 DS EOQ ! H ROP ! SS  Q LT SS ! zrW LT

Periodic Review System

RP ! EOQ / Q TIL ! SS  Q ( RP  LT ) SS ! zrW RP  LT

ABC Classification of Inventory Items

P e r c e n t a g e o f d o lla r v o l 100 90 80 70 60 50 40 30 20 10 0 0

Percentage of inventory items (SKUs)

10 0

10

20 30

40

50

60

70 80

90

Inventory Items Listed in Descending Order of Dollar Volume

Inventory Item Computers Entertainment center Television sets Refrigerators Monitors Stereos Cameras Software Computer disks CDs Totals Unit cost ($) 3000 2500 400 1000 200 150 200 50 5 20 Monthly Sales (units) 50 30 60 15 50 60 40 100 1000 200 Dollar Volume ($) 150,000 75,000 24,000 15,000 10,000 9,000 8,000 5,000 5,000 4,000 305,000 Percent of Dollar Volume 74 Percent of SKUs 20 Class A

16

30

10

50

100

100

Single Period Inventory Model

Newsvendor Problem Example
D = newspapers demanded p(D) = probability of demand Q = newspapers stocked P = selling price of newspaper, $10 C = cost of newspaper, $4 S = salvage value of newspaper, $2 Cu = unit contribution: P-C = $6 Co = unit loss: C-S = $2

Single Period Inventory Model Expected Value Analysis

p(D) .028 .055 .083 .111 .139 .167 .139 .111 .083 .055 .028 Expected Profit D 2 3 4 5 6 7 8 9 10 11 12 6 4 12 20 28 36 36 36 36 36 36 36 $31.54 7 2 10 18 26 34 42 42 42 42 42 42 $34.43 Stock Q 8 0 8 16 24 32 40 48 48 48 48 48 $35.77 9 -2 6 14 22 30 38 46 54 54 54 54 $35.99 10 -4 4 12 20 28 36 44 52 60 60 60 $35.33

Single Period Inventory Model Incremental Analysis

u E (loss on last sale) P ( revenue) (unit revenue) u P (loss) (unit loss)
E (revenue on last sale)

P ( D u Q)Cu u P ( D Q)Co

?1 P( D

Q) A u u P ( D C

Q)Co
(Critical Fractile)

Cu P ( D Q) e Cu  Co

where: Cu = unit contribution from newspaper sale ( opportunity cost of underestimating demand) Co = unit loss from not selling newspaper (cost of overestimating demand) D = demand Q = newspaper stocked

Critical fractile for the newsvendor problem

P(D<Q) (Co applies) P(D>Q) (Cu applies)

Pr oba bility

0.722

10

12

14

New spaper dem and, Q

Retail Discounting Model

S = current selling price D = discount price P = profit margin on cost (% markup as decimal) Y = average number of years to sell entire stock of dogs at current price (total years to clear stock divided by 2) N = inventory turns (number of times stock turns in one year) Loss per item = Gain from revenue S D = D(PNY)

S D! (1  PNY )

Topics for Discussion

Discuss the functions of inventory for different organizations in the supply chain. How would one find values for inventory costs? How can information technology create a competitive advantage through inventory management? How valid are the assumptions for the EOQ model? How is a service level determined for inventory items? What inventory model would apply to service capacity such as seats on an aircraft?

Interactive Exercise
The class engages in an estimation of the cost of a 12-ounce serving of Coke in various situations (e.g., supermarket, convenience store, fast-food restaurant, sit-down restaurant, and ballpark). What explains the differences?