OPSM 638 Supply Chain Management

1
OPSM 638 Supply Chain Management
Koç University Graduate School of Business MBA
Program

• Class 2
• Inventory basics

Zeynep Aksin zaksin_at_ku.edu.tr
2
Announcement

• Next session hands-on case analysis in class.
  Bring laptops and be ready to start at 1530.
• Read the first 3 exercise questions in
  Hamptonshire Express before coming to class
• Bring the case with you

3
Inventory

• Where do we hold inventory?
• Suppliers and manufacturers
• warehouses and distribution centers
• retailers
• Types of Inventory
• WIP
• raw materials
• finished goods
• Why do we hold inventory?
• Economies of scale
• Uncertainty in supply and demand

4
Goals Reduce Cost, Improve Service

• By effectively managing inventory
• Xerox eliminated 700 million inventory from its
  supply chain
• Wal-Mart became the largest retail company
  utilizing efficient inventory management
• GM has reduced parts inventory and transportation
  costs by 26 annually

5
Goals Reduce Cost, Improve Service

• By not managing inventory successfully
• In 1994, IBM continues to struggle with
  shortages in their ThinkPad line (WSJ, Oct 7,
  1994)
• In 1993, Liz Claiborne said its unexpected
  earning decline is the consequence of higher than
  anticipated excess inventory (WSJ, July 15,
  1993)
• In 1993, Dell Computers predicts a loss Stock
  plunges. Dell acknowledged that the company was
  sharply off in its forecast of demand, resulting
  in inventory write downs (WSJ, August 1993)

6
Understanding Inventory

• The inventory policy is affected by
• Demand Characteristics
• Lead Time
• Number of Products
• Objectives
• Service level
• Minimize costs
• Cost Structure

7
Cost Structure

• Order costs
• Fixed
• Variable
• Holding Costs
• Insurance
• Maintenance and Handling
• Taxes
• Opportunity Costs
• Obsolescence

8
Drivers of Supply Chain Performance
9
Sequential Optimization vs. Global Optimization
Source Duncan McFarlane
10
Coordination Concept
Supply chain management involves managing
processes across organization and firm
boundaries.
Sequential, myopic optimization
Upstream
Downstream
11
The Economic Lot Size Model (Harris 1915)

• Constant demand rate D
• Fixed order quantity Q
• Fixed set-up cost K
• Holding cost h
• Zero lead time
• Zero initial inventory
• Long (infinite) planning horizon

12
Example for a commodity good
Retailer
CR
Supplier
D
CS, KS, hS
KR, hR
There are economies of scale Retailer determines
order quantity Q Objective cost minimization
EOQ assumptions hold
13
Coordination for Commodity Products

• D 120,000 bottles/year
• KR 100, hR 0.2, CR 3
• KS 250, hS 0.2, CS 2
• Retailers optimal lot size 6,324 bottles
• Retailer cost 3,795
• Supplier cost 6,009
• Supply chain cost 9,804

14
Coordination for Commodity Products

• What can the supplier do to decrease supply chain
  costs?
• Coordinated lot size 9,165 Retailer cost
  4,059 Supplier cost 5,106 Supply chain cost
  9,165.
• Effective pricing schemes
• All unit quantity discount
• 3 for lots below 9,165
• 2.9978 for lots of 9,165 or more
• Pass some fixed cost to retailer (enough that he
  raises order size from 6,324 to 9,165)

15
Demand Scenarios
16
Costs

• Production cost per unit (C) 80
• Selling price per unit (S) 125
• Salvage value per unit (V) 20
• Fixed production cost (F) 100,000
• Q is production quantity, D demand
• Profit Revenue - Variable Cost - Fixed Cost
  Salvage

17
Best Solution

• Find order quantity that maximizes weighted
  average profit.
• Question Will this quantity be less than, equal
  to, or greater than average demand?

18
What to Make?

• Question Will this quantity be less than, equal
  to, or greater than average demand?
• Average demand is 13,100
• Look at marginal cost Vs. marginal profit
• if extra jacket sold, profit is 125-80 45
• if not sold, cost is 80-20 60
• So we will make less than average

19
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

20
Expected Profit
21
Expected Profit
22
Expected Profit
23
Important Observations

• Tradeoff between ordering enough to meet demand
  and ordering too much
• Several quantities have the same average profit
• Average profit does not tell the whole story
• Question 9000 and 16000 units lead to about the
  same average profit, so which do we prefer?

24
Probability of Outcomes
25
Key Insights from this Model

• The optimal order quantity is not necessarily
  equal to average forecast demand
• The optimal quantity depends on the relationship
  between marginal profit and marginal cost
• Fixed cost has no impact on production quantity,
  only on whether to produce or not
• As order quantity increases, average profit first
  increases and then decreases
• As production quantity increases, risk increases.
  In other words, the probability of large gains
  and of large losses increases