Chapter 6 Inventory Decision Making

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Chapter 6Inventory Decision Making

• Fundamental Approaches
• Fixed Order Quantity
• Fixed Order Interval
• Inventory at Multiple Locations
• Time Based Approaches
• QR and ECR
• Comparison of Various Methods

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Team Hanes

• Why was team Hanes profile included?
• Volatility of demand
• 5 day order turn around
• 95 order fill rate
• Account-specific price tagging
• Why an athletic event supplier?
• What happens at each level in the supply chain?

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Types of Demand

• Nature of Demand
• Independent vs. Dependent
• Driver or Trigger of Order
• Pull vs. Push or Hybrid
• Company or Supply Chain Philosophy
• System wide vs. Single-Facility Solution

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Basic Inventory Model
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Fixed Order Quantity (EOQ) Approach

• Key Questions
• How much to reorder?
• When to reorder?
• To minimize total cost?
• Two Tradeoffs
• Inventory Carrying Costs
• Order / Set-up Costs
• Principle Assumptions (CBL, pp. 195)
• Demand is continuous, constant, and known in
  advance
• Lead time is constant and known in advance
• Price of item is independent of order quantity

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Basic Tradeoffs

• As order quantity (EOQ) increases
• Annual inventory carrying cost also increases
• Annual ordering cost decreases
• Example MBL, pp. 196-198

Cost
Annual Cost
Cost
Size of Order Quantity
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Basic Tradeoffs
Total Costs

• As order quantity (EOQ) increases
• Annual inventory carrying cost also increases
• Annual ordering cost decreases
• Example CBL, pp. 196-198
• How do you determine optimum level?

Carrying Cost
Annual Cost
Order/Set-up Cost
Size of Order Quantity
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Average InventorySlope Demand/unit of
timeInventory carrying cost ½ Reorder Quantity
X carrying cost
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Mathematical Formulation

• Total Annual Cost Annual Inventory Carrying
  Cost Annual Ordering Cost
• Letting TAC Annual Total Cost ()
• R Annual demand (units)
• A Cost of placing a single order ()
• V Value of one unit of inventory ()
• W Inventory carrying cost as a of product
  value
• Q EOQ
• Then TAC 1/2 QVW A (R/Q)
• and the EOQ that minimizes the TAC is

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Example of EOQ

• R Annual demand 600 units
• A Order cost 4/order
• V Product value 240/unit
• W inventory carrying cost 20 0.20

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Example of TAC

• R Annual demand 600 units
• A Order cost 4/order
• V Product value 240/unit
• W inventory carrying cost 20 0.20
• Then
• TAC 1/2 QVW A (R/Q)
• 1/2 (10) (240) (0.20) (4) (600/10)
• 240 240
• 480

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Second QuestionWhen do you reorder?
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Reorder Point (when to order)

• The Goal is to have a shipment of EOQ units to
  arrive as the Balance-On-Hand 0
• 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)
• Continuing Example (Assume 300 days per year)
• Lead time length 12 days
• Then Demand per day 600 / 300
• 2 units/day
• ROP ( 12 days) ( 2 units/day)
• ROP 24 units
• Additional exercises to do at home CBL, pp. 230,
  7 and 8

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Average InventorySlope Demand/unit of
timeInventory carrying cost ½ Reorder Quantity
X carrying cost
Reorder Point
Time
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Related Concepts

• Two-bin system
• Min-max system
• demand may occur in larger increments than with
  the traditional EOQ approach

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But Life is not certain
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EOQ in Condition of Uncertainty

• Uncertainty variation in demand and/or lead
  time
• Requires holding of safety stock inventory
• Policy Cost of carrying safety stock should be
  balanced with expected cost of stockouts
• Average inventory 1/2 EOQ Safety Stock

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Inventory Model UnderConditions of Uncertainty

• EOQ is still the amount ordered each time
• Assumes that over time, uncertainty periods
  balance out

Inventory Level (Units)
ROP
Time
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Explanation of Graph

• Demand rate changes slope
• Varying demand during cycle can make line non
  linear
• Lead time changes
• Reorder point to receipt

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Anytime there is uncertainity

• Balance cost of stock out with cost of additional
  inventory
• Instead of planning on average demand and average
  lead time you plan on average plus X standard
  deviations
• If you plan around mean you would stock out 50
  of time

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Fixed Order Interval

• Involves ordering of inventory at fixed or
  regular intervals
• Amount order depends on how much is on-hand at
  the time of ordering (NOT EOQ)
• Implications
• Does not require close surveillance of inventory
  levels
• Inventory monitoring less expensive
• Over time, it results in higher safety stock
  levels

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Fixed order quantity is not only option

• Fixed order interval
• Every Thursday
• End of month
• Each night

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Fixed Interval Modal
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How many inventory locations should we have?
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Inventory at Multiple LocationsSquare Root Rule

• How does total inventory change as the number of
  stocking points changes?
• Let
• n1 number of existing facilities
• n2 number of future facilities
• x1 total inventory in present facilities
• x2 total inventory in future facilities

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Example Square Root Law

• Currently, the company has 50,000 units located
  in 3 facilities. The company plans to expand to
  27 locations. How will this affect total
  inventory?

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Are these the only way to replenish inventory?
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Human Nature likes safety stock

• Retail has a need for 1000 units
• Wholesaler wants to make sure they can handle
  retailers needs so they stock 1100
• Distributor wants to make sure they can handle
  wholesalers needs so they stock 1210
• Manufacturer wants to make sure they can handle
  distributors needs so they stock 1331 units
• With four member in the supply chain over stock
  is 33.1

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How do you avoid this problem?
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Time Based Approaches to Replenishment Logistics

• Continuous Replenishment (CRP) Inventory Systems
  based on POS data
• Flow-Through Logistics Systems (packing by
  destination)
• Pipeline (Supply Chain) Logistics Organizations
  (exchange of information based on expected needs)
• Pipeline Performance Measures (All members obtain
  data on performance at each level)

Note See Figure 6-12, MBL page 216 for further
detail.
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P G case

• Why is PG case presented?
• What did it take to improve process?
• What is demurrage?

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Quick Response (QR)

• How did it evolve?
• QR is a method of maximizing the efficiency of
  the supply chain by reducing inventory investment
  where partners commit to meet specific service
  performance criteria.
• shorter, compressed time horizons
• Real-time information by SKU
• Seamless logistics network
• Partnership relationships throughout the supply
  chain
• Commitment to Quality
• What were results?

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Basic Elementsof QR
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QR Profit Sources
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Time Savings from QR
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Impact on Department Store

• Joseph Haggars comments
• Impact on Haggar
• Impact on Dillards
• ( See page 221-222)

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Efficient Consumer Response (ECR)
Timely, accurate, paperless information flow
Consumer Household
Supplier
Distributor
Retail Store
Smooth, continual product flow matched to
consumption
Source Kurt Salmon Associates, Inc. Efficient
Consumer Response Enhancing Consumer Value in
the Grocery Industry
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ECR Overview

• Figure 6-18 (page 224)

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ECR

• Components
• Category management (Managing product groups as
  strategic business units)
• Integrated electronic data interchange (EDI)
• Activity-Based Costing (ABC)
• Continuous replenishment programs
• Flow-through cross-dock replenishment
• Benefits
• Better - products, assortments, in-stock
  performance, and prices
• Leaner, faster, more responsive, less costly
  supply chain
• Improved asset utilization

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ECR Impact on Dry Grocery Chain
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ECRs Effect on Cost
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Comparing EOQ and MRP
EOQ
MRP

• Independent demand
• Pull/push
• Sales forecast based on past experience
• Single facility

• Dependent demand
• Push
• Requirements based on current and future demand
• Entire system

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Comparing EOQ and MRP
EOQ
MRP

• Part based
• Independent demand
• Pull/push
• Sales forecast based on past experience
• Single facility

• Product based
• Dependent demand
• Push
• Requirements based on current and future demand
• Entire system

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Comparisons of Approaches
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Appendix 6A

• You will not be responsible for Appendix 6 A.