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CTL.

SC1xSupplyChainFundamentals

KeyConceptsDocument
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TableofContents
CoreSupplyChainConcepts.................................................................................................................3
DemandForecasting............................................................................................................................9
TimeSeriesAnalysis................................................................................................................................11
ExponentialSmoothing...........................................................................................................................13
ExponentialSmoothingwithHoltWinter...............................................................................................15
SpecialCases...........................................................................................................................................16
InventoryManagement.....................................................................................................................22
EconomicOrderQuantity(EOQ).............................................................................................................24
EconomicOrderQuantity(EOQ)Extensions...........................................................................................27
SinglePeriodInventoryModels..............................................................................................................31
SinglePeriodInventoryModelsExpectedProfitability...........................................................................34
ProbabilisticInventoryModels..............................................................................................................36
InventoryModelsforMultipleItems&Locations..................................................................................43
InventoryModelsforClassA&CItems..................................................................................................47
FundamentalsofFreightTransportation............................................................................................54
LeadTimeVariability&ModeSelection.................................................................................................55
OnetoManyDistribution.......................................................................................................................57

CTL.SC0xSupplyChainAnalytics 2

CoreSupplyChainConcepts
Summary
Virtuallyallsupplychainsareacombinationofpushandpullsystems.Apushsystemiswhere
executionisperformedaheadofanactualordersothattheforecasteddemand,ratherthan
actualdemand,hastobeusedinplanning.Apullsystemiswhereexecutionisperformedin
responsetoanordersothattheactualdemandisknownwithcertainty.Thepointinthe
processwhereasupplychainshiftsfrombeingpushtopullissometimescalledthepush/pull
boundaryorpush/pullpoint.Inmanufacturing,thepush/pullpointisalsoknownasthe
decouplingpoint(DP)orcustomerorderdecouplingpoint(CODP).TheCODPcoincideswithan
importantstockpoint,wherethecustomerorderarrives(switchinginventorybasedona
forecasttoactualdemand),andalsoallowstodifferentiatebasicproductionsystems:maketo
stock,assembletoorder,maketoorder,orengineertoorder.

Postponementisacommonstrategytocombinethebenefitsofpush(productreadyfor
demand)andpull(fastcustomizedservice)systems.Postponementiswherethe
undifferentiatedraworcomponentsarepushedthroughaforecast,andthefinalfinishedand
customizedproductsarethenpulled.

Segmentationisamethodofdividingasupplychainintotwoormoregroupingswherethe
supplychainsoperatedifferentlyandmoreefficientlyand/oreffectively.Whilethereareno
absoluterulesforsegmentation,therearesomerulesofthumb,suchas:itemsshouldbe
homogenouswithinthesegmentandheterogeneousacrosssegments;thereshouldbecritical
masswithineachsegment;andthesegmentsneedtobeusefulandcommunicable.Asegment
onlymakessenseifitdoessomethingdifferent(planning,inventory,transportationetc.)from
theothersegments.ThemostcommonsegmentationisforproductsusinganABC
classification.

InanABCsegmentation,theproductsdrivingthemostrevenue(orprofitorsales)areClassA
items(theimportantfew).Productsdrivingverylittlerevenue(orprofitorsales)areClassC
items(thetrivialmany),andtheproductsinthemiddleareClassB.Acommonbreakdownis
thetop20%ofitems(ClassA)generate80%oftherevenue,ClassBis30%oftheproducts
generating15%oftherevenue,andtheClassCitemsgeneratelessthan5%oftherevenue
whileconstituting50%oftheitems.

Supplychainsoperateinuncertainty.Demandisneverknownexactly,forexample.Inorderto
handleandbeabletoanalyzesystemswithuncertainty,weneedtocapturethedistributionof
thevariableinquestion.Whenwearedescribingarandomsituation,say,theexpected
demandforpizzasonaThursdaynight,itishelpfultodescribethepotentialoutcomesinterms
ofthecentraltendency(meanormedian)aswellasthedispersion(standarddeviation,range).
Wewilloftencharacterizethedistributionofpotentialoutcomesasfollowingawellknown
functionsuchasNormalandPoisson.

CTL.SC0xSupplyChainAnalytics 3

KeyConcepts
Pullvs.PushProcess
Pushworkperformedinanticipationofanorder(forecasteddemand)
Pullexecutionperformedinresponsetoanorder(demandknownwithcertainty)
HybridorMixedpushrawproducts,pullfinishedproduct(postponementordelayed
differentiation)
Push/pullboundarypointpointintheprocesswhereasupplychainshiftsfrombeing
pushtopull
Inmanufacturing,alsoknownasdecouplingpoint(DP)orcustomerorderdecoupling
point(CODP)thepointinthematerialflowwheretheproductislinkedtoaspecific
customer
Masscustomization/Postponementtodelaythefinalassembly,customization,or
differentiationofaproductuntilaslateaspossible

Segmentation
Differentiateproductsinordertomatchtherightsupplychaintotherightproduct
Productstypicallysegmentedon
o Physicalcharacteristics(value,size,density,etc.)
o Demandcharacteristics(salesvolume,volatility,salesduration,etc.)
o Supplycharacteristics(availability,location,reliability,etc.)
Rulesofthumbfornumberofsegments
o Homogeneousproductswithinasegmentshouldbesimilar
o Heterogeneousproductsacrosssegmentsshouldbeverydifferent
o CriticalMasssegmentshouldbebigenoughtobeworthwhile
o Pragmaticsegmentationshouldbeusefulandcommunicable
Demandfollowsapowerlawdistribution,meaningalargevolumeofsalesis
concentratedinfewproducts

PowerLaw
ThedistributionofpercentsalesvolumetopercentofSKUs(StockKeepingUnits)tendsto
followaPowerLawdistribution(y=axk)whereyispercentofdemand(unitsorsalesorprofit),x
ispercentofSKUs,andaandkareparameters.Thevalueforkshouldobviouslybelessthan1
sinceifk=1therelationshipislinear.Inadditiontosegmentingaccordingtoproducts,many
firmssegmentbycustomer,geographicregion,orsupplier.Segmentationistypicallydone
usingrevenueasthekeydriver,butmanyfirmsalsoincludevariabilityofdemand,profitability,
andotherfactors,toinclude:
Revenue=averagesales*unitsalesprice;
Profit=averagesales*margin;

CTL.SC0xSupplyChainAnalytics 4

Margin=unitsalespriceunitcost.

HandlingUncertainty
Uncertaintyofanoutcome(demand,transittime,manufacturingyield,etc.)ismodeled
throughaprobabilitydistribution.Wediscussedtwointhelesson:PoissonandNormal.

NormalDistribution~N(,)
ThisistheBellShapeddistributionthatiswidelyusedbybothpractitionersandacademics.
Whilenotperfect,itisagoodplacetostartformostrandomvariablesthatyouwillencounter
inpracticesuchastransittimeanddemand.Thedistributionisbothcontinuous(itcantake
anynumber,notjustintegersorpositivenumbers)andissymmetricarounditsmeanor
average.Beingsymmetricadditionallymeansthemeanisalsothemedianandthemode.The
commonnotationthatwewillusetoindicatethatsomevaluefollowsaNormalDistributionis
~N(,)wheremu,,isthemeanandsigma,,isthestandarddeviation.Somebooksusethe
notation~N(,2)showingthevariance,2,insteadofthestandarddeviation.Justbesure
whichnotationisbeingfollowedwhenyouconsultothertexts.

TheNormalDistributionisformallydefinedas:
( x0 )2
2 x2
e

f x x0
x 2

WewillalsomakeuseoftheUnitNormalorStandardNormalDistribution.Thisis~N(0,1)
wherethemeaniszeroandthestandarddeviationis1(asisthevariance,obviously).Thechart
belowshowsthestandardorunitnormaldistribution.Wewillbemakinguseofthe
transformationfromanyNormalDistributiontotheUnitNormal(SeeFigure1).

StandardNormalDistribution(=0,2=1)
45%
40%
35%
30%
25% 2=1
20%
15%
10%
5%
0% =0
6 4 2 0 2 4 6

Figure1.StandardNormalDistribution

Wewillmakeextensiveuseofspreadsheets(whetherExcelorLibreOffice)tocalculate
probabilitiesundertheNormalDistribution.Thefollowingfunctionsarehelpful:

CTL.SC0xSupplyChainAnalytics 5

NORMDIST(x,,,true)=theprobabilitythatarandomvariableislessthanorequalto
xundertheNormalDistribution~N(,).So,thatNORMDIST(25,20,3,1)=0.952
whichmeansthatthereisa95.2%probabilitythatanumberfromthisdistributionwill
belessthan25.
NORMINV(probability,,)=thevalueofxwheretheprobabilitythatarandom
variableislessthanorequaltoitisthespecifiedprobability.So,NORMINV(0.952,20,3)
=25.

TousetheUnitNormalDistribution~N(0,1)weneedtotransformthegivendistributionby
calculatingakvaluewherek=(x)/.Thisissometimescalledazvalueinstatisticscourses,
butinalmostallsupplychainandinventorycontextsitisreferredtoasakvalue.So,inour
example,k=(2520)/3=1.67.WhydoweusetheUnitNormal?Well,thekvalueisahelpful
andconvenientpieceofinformation.Thekisthenumberofstandarddeviationsthevaluexis
above(orbelowifitisnegative)themean.Wewillbelookingatanumberofspecificvalues
forkthatarewidelyusedasthresholdsinpractice,specifically:
Probability(x0.90)wherek=1.28
Probability(x0.95)wherek=1.62
Probability(x0.99)wherek=2.33

BecausetheNormalDistributionissymmetric,therearealsosomecommonconfidence
intervals:
68.3%meaningthat68.3%ofthevaluesfallwithin1standarddeviationofthe
mean,
2 95.5%95.5%ofthevaluesfallwithin2standarddeviationsofthemean,and
3 99.7%99.7%ofthevaluesfallwithin3standarddeviationsofthemean.

Inaspreadsheetsyoucanusethefunctions:
NORMSDIST(k)=theprobabilitythatarandomvariableislessthankunitsabove(or
below)mean.Forexample,NORMSDIST(2.0)=0.977meaningthe97.7%ofthe
distributionislessthan2standarddeviationsabovethemean.
NORMSINV(probability)=thevaluecorrespondingtothegivenprobability.Sothat
NORMSINV(0.977)=2.0.IfIthenwantedtofindthevaluethatwouldcover97.7%ofa
specificdistribution,saywhere~N(279,46)Iwouldjusttransformit.Sincek=(x)/
forthetransformation,Icansimplysolveforxandget:x=+k=279+(2.0)(46)=
371.Thismeansthattherandomvariable~N(279,46)willbeequalorlessthan371for
97.7%ofthetime.

Poissondistribution~Poisson()
WewillalsousethePoisson(pronouncedpwaSOHN)distributionformodelingthingslike
demand,stockouts,andotherlessfrequentevents.ThePoisson,unliketheNormal,isdiscrete
(itcanonlybeintegers0),alwayspositive,andnonsymmetric.Itisskewedrightthatis,it

CTL.SC0xSupplyChainAnalytics 6

hasalongrighttail.Itisverycommonlyusedforlowvaluedistributionsorslowmovingitems.
WhiletheNormalDistributionhastwoparameters(muandsigma),thePoissononlyhasone,
lambda,.

Formally,thePoissonDistributionisdefinedasshownbelow:
e 0
x
p[x0 ] Prob x x0 for x0 0,1,2,...
x0 !
x0
e x
F[x0 ] Prob x x0
x!
x0

Thechartbelow(Figure2)showsthePoissonDistributionfor=3.ThePoissonparameteris
boththemeanandthevarianceforthedistribution!Notethatdoesnothavetobean
integer.

PoissonDistribution(=3)
25%

20%

15%
P(x=x0)

10%

5%

0%
0 1 2 3 4 5 6 7 8 9
x

Figure2.PoissonDistribution
Inspreadsheets,thefollowingfunctionsarehelpful:
POISSON(x0,,false)=>P(x=x0)=theprobabilitythatarandomvariableisequaltox0
underthePoissonDistribution~P().So,thatPOISSON(2,1.56,0)=0.256whichmeans
thatthereisa25.6%probabilitythatanumberfromthisdistributionwillbeequalto2.
POISSON(x0,,true)=>P(xx0)=theprobabilitythatarandomvariableislessthanor
equaltox0underthePoissonDistribution~P().So,thatPOISSON(2,1.56,1)=0.793
whichmeansthatthereisa79.3%probabilitythatanumberfromthisdistributionwill
belessthanorequalto2.Thisissimplyjustthecumulativedistributionfunction.

Uniformdistribution~U(a,b)
WewillsometimesusetheUniformdistribution,whichhastwoparameters:aminimumvaluea
andamaximumvalueb.Eachpointwithinthisrangeisequallylikelytooccur.Tofindthe
cumulativeprobabilityforsomevalueC,theprobabilitythatxc=(ca)/(ba),thatis,thearea
fromatocminusthetotalareafromatob.Theexpectedvalueorthemeanissimply(a+b)/2
whilethestandarddeviationis= /12.

CTL.SC0xSupplyChainAnalytics 7


LearningObjectives
Identifyandunderstanddifferencesbetweenpushandpullsystems.
Understandwhyandhowtosegmentsupplychainsbyproducts,customers,etc.
Abilitytomodeluncertaintyinsupplychains,primarily,butnotexclusively,indemand
uncertainty.

References
Push/PullProcesses:Chopra&MeindlChpt1;NahmiasChpt7;
Segmentation:NahmiasChpt5;Silver,Pyke,&PetersonChpt3;BallouChpt3
ProbabilityDistributions:Chopra&MeindlChpt12;NahmiasChpt5;Silver,Pyke,&Peterson
AppB

Fisher,M.(1997)WhatIstheRightSupplyChainforYourProduct?,HarvardBusinessReview.

Olavson,T.,Lee,H.&DeNyse,G.(2010)APortfolioApproachtoSupplyChainDesign,Supply
ChainManagementReview.

CTL.SC0xSupplyChainAnalytics 8

DemandForecasting
Summary
ForecastingisoneofthreecomponentsofanorganizationsDemandPlanning,Forecasting,and
Managementprocess.DemandPlanninganswersthequestionWhatshouldwedotoshape
andcreatedemandforourproduct?andconcernsthingslikepromotions,pricing,packaging,
etc.DemandForecastingthenanswersWhatshouldweexpectdemandforourproducttobe
giventhedemandplaninplace?Thefinalcomponent,DemandManagement,answersthe
question,Howdoweprepareforandactondemandwhenitmaterializes?Thisconcerns
thingslikeSales&OperationsPlanning(S&OP)andbalancingsupplyanddemand.

WithintheDemandForecastingcomponent,youcanthinkofthreelevels,eachwithitsown
timehorizonandpurpose.Strategicforecasts(years)areusedforcapacityplanning,
investmentstrategies,etc.Tacticalforecasts(weekstomonthstoquarters)areusedforsales
plans,shorttermbudgets,inventoryplanning,laborplanning,etc.Finally,operationsforecasts
(hourstodays)areusedforproduction,transportation,andinventoryreplenishmentdecisions.
Thetimeframeoftheactiondictatesthetimehorizonoftheforecast.

Forecastingmethodscanbedividedintobeingsubjective(mostoftenusedbymarketingand
sales)orobjective(mostoftenusedbyproductionandinventoryplanners).Subjective
methodscanbefurtherdividedintobeingeitherJudgmental(someonesomewhereknowsthe
truth),suchassalesforcesurveys,Delphisessions,orexpertopinions,orExperimental
(samplinglocalandthenextrapolating),suchascustomersurveys,focusgroups,ortest
marketing.ObjectivemethodsareeitherCausal(thereisanunderlyingrelationshiporreason)
suchasleadingindicators,etc.orTimeSeries(therearepatternsinthedemand)suchas
exponentialsmoothing,movingaverage,etc.Allmethodshavetheirplaceandtheirrole.We
willspendalotoftimeontheobjectivemethodsbutwillalsodiscussthesubjectiveonesas
well.

Regardlessoftheforecastingmethodused,youwillwanttomeasurethequalityofthe
forecast.Thetwomajordimensionsofqualityarebias(apersistenttendencytooveror
underpredict)andaccuracy(closenesstotheactualobservations).Nosinglemetricdoesa
goodjobcapturingbothdimensions,soitisworthhavingmultiple.

KeyConcepts
Forecastingisbothanartandascience.Therearemanytruismsconcerningforecasting
including:

ForecastingTruisms

CTL.SC0xSupplyChainAnalytics 9

1. ForecastsarealwayswrongYes,pointforecastswillneverbecompletelyperfect.The
solutionistonotrelytotallyonpointforecasts.Incorporaterangesintoyourforecasts.
Alsoyoushouldtrytocaptureandtracktheforecasterrorssothatyoucansenseand
measureanydriftorchanges.
2. AggregatedforecastsaremoreaccuratethandisaggregatedforecastsTheideaisthat
combiningdifferentitemsleadstoapoolingeffectthatwillinturnlessenthevariability.
Thepeaksbalanceoutthevalleys.Thecoefficientofvariation(CV)iscommonlyusedto
measurevariabilityandisdefinedasthestandarddeviationoverthemean / .
ForecastsaregenerallyaggregatedbySKU(afamilyofproductsversusanindividual
one),time(demandoveramonthversusoverasingleday),orlocation(demandfora
regionversusasinglestore).
3. ShorterhorizonforecastsaremoreaccuratethanlongerhorizonforecastsEssentially
thismeansthatforecastingtomorrowstemperature(ordemand)iseasierandprobably
moreaccuratethanforecastingforayearfromtomorrow.Thisisnotthesameas
aggregating.Itisallaboutthetimebetweenmakingtheforecastandtheevent
happening.Shorterisalwaysbetter.Thisiswherepostponementandmodularization
helps.Ifwecansomehowshortentheforecastingtimeforanenditem,wewill
generallybemoreaccurate.

ForecastingMetrics
Thereisacosttradeoffbetweencostoferrorsinforecastingandcostofqualityforecasts
thatmustbebalanced.Forecastmetricsystemsshouldcapturebiasandaccuracy.

Notation
At:Actualvalueforobservationt
Ft:Forecastedvalueforobservationt
et:Errorforobservationt,
n:numberofobservations
:mean
:standarddeviation
CV:CoefficientofVariationameasureofvolatility

CTL.SC0xSupplyChainAnalytics 10

Formulas:


MeanDeviation:
| |

MeanAbsoluteDeviation:


MeanSquaredError:


RootMeanSquaredError:
MeanPercentError:




MeanAbsolutePercentError:


StatisticalAggregation:


StatisticalAggregationofnDistributionsofEqualMeanandVariance:









TimeSeriesAnalysis
TimeSeriesisanextremelywidelyusedforecastingtechniqueformidrangeforecastsforitems
thathavealonghistoryorrecordofdemand.Timeseriesisessentiallypatternmatchingof
datathataredistributedovertime.Forthisreason,youtendtoneedalotofdatatobeableto
capturethecomponentsorpatterns.Businesscyclesaremoresuitedtolongerrange,strategic
forecastingtimehorizons.
Threeimportanttimeseriesmodels:
Cumulativewhereeverythingmattersandalldataareincluded.Thisresultsinavery
calmforecastthatchangesveryslowlyovertimethusitismorestablethan
responsive.
Navewhereonlythelatestdatapointmatters.Thisresultsinverynervousorvolatile
forecastthatcanchangequicklyanddramaticallythusitismoreresponsivethan
stable.
MovingAveragewherewecanselecthowmuchdatatouse(thelastMperiods).This
isessentiallythegeneralizedformforboththeCumulative(M=)andNave(M=1)
models.

CTL.SC0xSupplyChainAnalytics 11

Allthreeofthesemodelsaresimilarinthattheyassumestationarydemand.Anytrendinthe
underlyingdatawillleadtoseverelagging.Thesemodelsalsoapplyequalweightingtoeach
pieceofinformationthatisincluded.Interestingly,whiletheMPeriodMovingAveragemodel
requiresMdataelementsforeachSKUbeingforecast,theNaveandCumulativemodelsonly
require1dataelementeach.

Componentsoftimeseries

Level(a)
o Valuewheredemandhovers(mean)
o Capturesscaleofthetimeseries
o Withnootherpatternpresent,itisa
constantvalue

Trend(b)
o Rateofgrowthordecline
o Persistentmovementinonedirection
o Typicallylinearbutcanbeexponential,
quadratic,etc.

SeasonVariations(F)
o Repeatedcyclearoundaknownandfixed
period
o Hourly,daily,weekly,monthly,quarterly,etc.
o Canbecausedbynaturalormanmadeforces

RandomFluctuation(eor)
o Remainderofvariabilityafterothercomponents
o Irregularandunpredictablevariations,noise

CTL.SC0xSupplyChainAnalytics 12


Notation
xt: Actualdemandinperiodt
, :Forecastfortimet+1madeduringtimet
a: Levelcomponent
b: Lineartrendcomponent
Ft: Seasonindexappropriateforperiodt
et: Errorforobservationt,
t: Timeperiod(0,1,2,n)
LevelModel:
TrendModel:
MixLevelSeasonalityModel:
MixLevelTrendSeasonalityModel:

Formulas
TimeSeriesModels(StationaryDemandonly):

CumulativeModel: ,
NaveModel: ,

MPeriodMovingAverageForecastModel: ,
IfM=t,wehavethecumulativemodelwherealldataisincluded
IfM=1,wehavethenavemodel,wherethelastdatapointisusedtopredictthe
nextdatapoint

ExponentialSmoothing
Exponentialsmoothing,asopposedtoCumulative,Nave,andMovingAverage,treatsdata
differentlydependingonitsage.Theideaisthatthevalueofdatadegradesovertimesothat
newerobservationsofdemandareweightedmoreheavilythanolderobservations.The
weightsdecreaseexponentiallyastheyage.Exponentialmodelssimplyblendthevalueofnew
andoldinformation.

Thealphafactor(rangingbetween0and1)determinestheweightingforthenewest
informationversustheolderinformation.Thevalueindicatesthevalueofnew
informationversusoldinformation:
As1,theforecastbecomesmorenervous,vola le,andnave
As0,theforecastbecomesmorecalm,staid,andcumulative
canrangefrom01,butinpractice,wetypicallysee00.3
Themostbasicexponentialmodel,orSimpleExponentialmodel,assumesstationarydemand.
HoltsModelisamodifiedversionofexponentialsmoothingthatalsoaccountsfortrendin

CTL.SC0xSupplyChainAnalytics 13

additiontolevel.Anewsmoothingparameter,,isintroduced.Itoperatesinthesamewayas
the.
Wecanalsouseexponentialsmoothingtodampentrendmodelstoaccountforthefactthat
trendsusuallydonotremainunchangedindefinitelyaswellasforcreatingamorestable
estimateoftheforecasterrors.

Notation
xt: Actualdemandinperiodt
x , : Forecastfortimet+1madeduringtimet
: Exponentialsmoothingfactorforlevel(01)
: Exponentialsmoothingfactorfortrend(01)
: Exponentialsmoothingfactorfordampening(01)
: MeanSquareErrortrendingfactor(0.010.1)
ForecastingModels
SimpleExponentialSmoothingModel(LevelOnly)Thismodelisusedforstationary
demand.Thenewinformationissimplythelatestobservation.Theoldinformationis
themostrecentforecastsinceitencapsulatestheolderinformation.
, 1 ,

DampedTrendModelwithLevelandTrendWecanuseexponentialsmoothingto
dampenalineartrendtobetterreflectthetaperingeffectoftrendsinpractice.

1
1

ExponentialSmoothingforLevel&TrendalsoknownasHoltsMethod,assumesalinear
trend.Theforecastfortimet+madeattimetisshownbelow.Itisacombinationofthe
latestestimatesofthelevelandtrend.Forthelevel,thenewinformationisthelatest
observationandtheoldinformationisthemostrecentforecastforthatperiodthatis,the
lastperiodsestimateoflevelplusthelastperiodsestimateoftrend.Forthetrend,thenew
informationisthedifferencebetweenthemostrecentestimateofthelevelminusthe
secondmostrecentestimateofthelevel.Theoldinformationissimplythelastperiods
estimateofthetrend.
,
1
1

CTL.SC0xSupplyChainAnalytics 14

MeanSquareErrorEstimateWecanalsouseexponentialsmoothingtoprovideamore
robustorstablevalueforthemeansquareerroroftheforecast.
, 1

ExponentialSmoothingwithHoltWinter
Seasonality
Formultiplicativeseasonality,thinkoftheFiaspercentofaveragedemandfora
periodi
ThesumoftheFiforallperiodswithinaseasonmustequalP
Seasonalityfactorsmustbekeptcurrentortheywilldriftdramatically.Thisrequiresa
lotmorebookkeeping,whichistrickytomaintaininaspreadsheet,butitisimportantto
understand

ForecastingModelParameterInitializationMethods
Whilethereisnosinglebestmethod,therearemanygoodones
SimpleExponentialSmoothing
o Estimatelevelparameter byaveragingdemandforfirstseveralperiods
HoltModel(trendandlevel)mustestimateboth and
o Findabestfitlinearequationfrominitialdata
o Useleastsquaresregressionofdemandforseveralperiods
Dependentvariable=demandineachtimeperiod=xt
Independentvariable=slope=1
Regressionequation:xt=0+1t
SeasonalityModels
o Muchmorecomplicated,youneedatleasttwoseasonofdatabutpreferably
fourormore
o Firstdeterminethelevelforeachcommonseasonperiodandthenthedemand
forallperiods
o Setinitialseasonalityindicestoratioofeachseasontoallperiods

Notation
xt: Actualdemandinperiodt
x , : Forecastfortimet+1madeduringtimet
: Exponentialsmoothingfactor(01)
: Exponentialsmoothingtrendfactor(01)
: Seasonalitysmoothingfactor(01)
Ft: Multiplicativeseasonalindexappropriateforperiodt
P: Numberoftimeperiodswithintheseasonality(note: F P)

CTL.SC0xSupplyChainAnalytics 15


ForecastingModels
DoubleExponentialSmoothing(SeasonalityandLevel)Thisisamultiplicativemodelin
thattheseasonalityforeachperiodistheproductofthelevelandthatperiodsseasonality
factor.Thenewinformationfortheestimateofthelevelisthedeseasonedvalueofthe
latestobservation;thatis,youaretryingtoremovetheseasonalityfactor.Theold
informationissimplythepreviousmostrecentestimateforlevel.Fortheseasonality
estimate,thenewinformationisthedeleveledvalueofthelatestobservation;thatis,you
trytoremovethelevelfactortounderstandanynewseasonality.Theoldinformationis
simplythepreviousmostrecentestimateforthatperiodsseasonality.
,

HoltWinterExponentialSmoothingModel(Level,Trend,andSeasonality)Thismodel
assumesalineartrendwithamultiplicativeseasonalityeffectoverbothlevelandtrend.For
thelevelestimate,thenewinformationisagainthedeseasonedvalueofthelatest
observation,whiletheoldinformationistheoldestimateofthelevelandtrend.The
estimateforthetrendisthesameasfortheHoltmodel.TheSeasonalityestimateisthe
sameastheDoubleExponentialsmoothingmodel.
,

1
1

NormalizingSeasonalityIndicesThisshouldbedoneaftereachforecasttoensurethe
seasonalitydoesnotgetoutofsynch.Iftheindicesarenotupdated,theywilldrift
dramatically.Mostsoftwarepackageswilltakecareofthisbutitisworthchecking.

SpecialCases
Therearedifferenttypesofnewproductsandtheforecastingtechniquesdifferaccordingto
theirtype.Thefundamentalideaisthatifyoudonothaveanyhistorytorelyon,youcanlook

CTL.SC0xSupplyChainAnalytics 16

forhistoryofsimilarproductsandbuildone.BassDiffusionmodelscanbeusedtoestimate
marketdemandfornewtoworldproducts.

Whenthedemandisverysparse,suchasforspareparts,wecannotusetraditionalmethods
sincetheestimatestendtofluctuatedramatically.Crostonsmethodcansmoothoutthe
estimateforthedemand.

NewProductTypes
Notallnewproductsarethesame.Wecanroughlyclassifythemintothefollowing
sixcategories(listedfromeasiesttoforecasttohardest):
o CostReductions:Reducedpriceversionoftheproductfortheexisting
market
o ProductRepositioning:Takingexistingproducts/servicestonewmarketsor
applyingthemtoanewpurpose(aspirinfrompainkillertoreducingeffects
ofaheartattack)
o LineExtensions:Incrementalinnovationsaddedtocomplementexisting
productlines(VanillaCoke,CokeZero)orProductImprovements:New,
improvedversionsofexistingofferingtargetedtothecurrentmarket
replacesexistingproducts(nextgenerationofproduct)
o NewtoCompany:Newmarket/categoryforthecompanybutnottothe
market(AppleiPhoneoriPod)
o NewtoWorld:Firstoftheirkind,createsnewmarket,radicallydifferent
(SonyWalkman,Postitnotes,etc.)
Whiletheyareapaintoforecastandtolaunch,firmsintroducenewproductsallthe
timethisisbecausetheyaretheprimarywaytoincreaserevenueandprofits(See
Table1)


*Majorrevisions/incrementalimprovementsaboutevenlysplit
Table1.Newproductintroductions.Source:AdaptedfromCooper,Robert(2001)WinningatNewProducts,Kahn,Kenneth
(2006)NewProductforecasting,andPDMA(2004)NewProductDevelopmentReport.)

CTL.SC0xSupplyChainAnalytics 17

NewProductDevelopmentProcess
Allfirmsusesomeversionoftheprocessshownbelowtointroducenewproducts.Thisis
sometimescalledthestagegateorfunnelprocess.Theconceptisthatlotsofideascomeinon
theleftandveryfewfinalproductscomeoutontheright.Eachstageorhurdleintheprocess
winnowsoutthewinnersfromthelosersandisusedtofocusattentionontherightproducts.
ThescopeandscaleofforecastingchangesalongtheprocessasnotedinFigure3.


Figure3.Newproductdevelopmentprocess

ForecastingModelsDiscussed
NewProductLooksLikeorAnalogousForecasting
Performbylookingatcomparableproductlaunchesandcreateaweekbyweekor
monthbymonthsalesrecord.
Thenusethepercentoftotalsalesineachtimeincrementasatrajectoryguide.
Eachlaunchshouldbecharacterizedbyproducttype,seasonofintroduction,price,
targetmarketdemographics,andphysicalcharacteristics.

NewtoWorldProductsBassDiffusionModel
Theideaisthattherearetwocomplementaryeffectsatwork,innovationandimitation:
o Innovationeffect:Innovatorsareearlyadoptersthataredrawntotechnology
regardlessofwhoelseisusingit.Theirdemandpeaksearlyintheproducts
lifecycle.
o Imitationeffect:Imitatorshearabouttheproductbywordofmouthandare
influencedbypeers.Theirdemandlagsbehindtheinnovators.
Thevaluesforp(innovation)andq(imitation)canbeestimatedusingvarious
techniques.

IntermittentorSparseDemandCrostonsMethod

CTL.SC0xSupplyChainAnalytics 18

Usedforproductsthatareinfrequentlyorderedinlargequantities,irregularlyordered,
ororderedindifferentsizes.
CrostonsMethodseparatesoutthedemandandmodelunbiasedandhaslower
variancethansimplesmoothing.
Cautions:infrequentordering(andupdatingofmodel)inducesalagtorespondingto
magnitudechanges.

Notation
P: InnovationeffectinBassDiffusionModel;p~0.03andoften<0.01
q: ImitationeffectinBassDiffusionModel;q~0.38andoften0.3q0.5
m: Totalnumberofcustomerswhowilladopt
n(t): Numberofcustomeradoptingattimet
N(t1): Cumulativenumberofsalesbytimet1
t*: PeaksalestimeinBassDiffusionModel
xt: Demandinperiodt
yt: 1iftransactionoccursinperiodt,=0otherwise
zt: Size(magnitude)oftransactionintimet
nt: Numberofperiodssincelasttransaction
: Smoothingparameterformagnitude
: Smoothingparameterfortransactionfrequency

Formulas
BassDiffusionModel
n(t)=p*[RemainingPotential]+q*[Adopters]*[RemainingPotential]
1
1 1
PeaksalestimeperiodusingBassDiffusionassumingacontinuousvalueoftime(notyearby
year).
ln

WecanuseregressiontoestimateBassDiffusionparameters.Thedependentvariable,nt,isa
functionofthepreviouscumulativesales,Nt1,anditssquareandtakestheform:

Then,inordertofindthevaluesofm(totalnumberofcustomers),p(innovationfactor),andq
(imitationfactor),weusethefollowingformulas:
4

2


CTL.SC0xSupplyChainAnalytics 19

CrostonsMethod
WecanuseCrostonsmethodwhendemandisintermittent.Itallowsustousethetraditional
exponentialsmoothingmethods.WeassumetheDemandProcessis t= tztandthatdemand
isindependentbetweentimeperiods,sothattheprobabilitythatatransactionoccursinthe
currenttimeperiodis1/n:
1 1
1 0 1
UpdatingProcedure:
Ifxt=0(notransactionoccurs),then

Ifxt>0(transactionoccurs),then
1
1
Forecast:

LearningObjectives
ForecastingispartoftheentireDemandPlanningandManagementprocess.
Rangeforecastsarebetterthanpointforecasts,aggregatedforecastsarebetterthan
disaggregated,andshortertimehorizonsarebetterthanlonger.
Forecastingmetricsneedtocapturebiasandaccuracy.
Understandhowtoinitializeaforecast.
UnderstandthatTimeSeriesisausefultechniquewhenwebelievedemandfollows
certainrepeatingpatterns.
Recognizethatalltimeseriesmodelsmakeatradeoffbetweenbeingnave(usingonly
thelastmostrecentdata)orcumulative(usingalloftheavailabledata).
Understandhowexponentialsmoothingtreatsoldandnewinformationdifferently.
Understandhowchangingthealphaorbetasmoothingfactorsinfluencestheforecasts.
Understandhowseasonalitycanbehandledwithinexponentialsmoothing.
Understandwhydemandfornewproductsneedtobeforecastedwithdifferent
techniques.
LearnhowtousebasicDiffusionModelsfornewproductdemandandhowtoforecast
intermittentdemandusingCrostonsMethod.
Understandhowthetypicalnewproductpipelineprocess(stage.gate)worksandhow
forecastingfitsin.

CTL.SC0xSupplyChainAnalytics 20

References
GeneralDemandForecasting
Makridakis,Spyros,StevenC.Wheelwright,andRobJ.Hyndman.Forecasting:Methods
andApplications.NewYork,NY:Wiley,1998.ISBN9780471532330.
Hyndman,RobJ.andGeorgeAthanasopoulos.Forecasting:PrinciplesandPractice.
OTexts,2014.ISBN0987507109.
Gilliland,Michael.TheBusinessForecastingDeal:ExposingBadPracticesandProviding
PracticalSolutions.Hoboken,NJ:Wiley,2010.ISBN0470574437.

Withinthetextsmentionedearlier:Silver,Pyke,andPetersonChapter4.1;Chopra&Meindl
Chapter7.17.4;NahmiasChapter2.12.6.
Also,IrecommendcheckingouttheInstituteofBusinessForecasting&Planning
(https://ibf.org/)andtheirJournalofBusinessForecasting.

ForTimeSeriesAnalysis
Withinthetextsmentionedearlier:Silver,Pyke,andPetersonChapter4.25.5.1&4.6;Chopra
&MeindlChapter7.57.6;NahmiasChapter2.7.
Also,IrecommendcheckingouttheInstituteofBusinessForecasting&Planning
(https://ibf.org/)andtheirJournalofBusinessForecasting.
Makridakis,Spyros,StevenC.Wheelwright,andRobJ.Hyndman.Forecasting:Methods
andApplications.NewYork,NY:Wiley,1998.ISBN9780471532330.
Hyndman,RobJ.andGeorgeAthanasopoulos.Forecasting:PrinciplesandPractice.
OTexts,2014.ISBN0987507109.

ForExponentialSmoothing
Silver,E.A.,Pyke,D.F.,Peterson,R.InventoryManagementandProductionPlanningand
Scheduling.ISBN:9780471119470.Chapter4.
Chopra,Sunil,andPeterMeindl.SupplyChainManagement:Strategy,Planning,and
Operation.5thedition,PearsonPrenticeHall,2013.Chapter7.
Nahmias,S.ProductionandOperationsAnalysis.McGrawHillInternationalEdition.
ISBN:00722312653.Chapter2.

ForSpecialCases
Cooper,RobertG.WinningatNewProducts:AcceleratingtheProcessfromIdeato
Launch.Cambridge,MA:PerseusPub.,2001.Print.
Kahn,KennethB.NewProductForecasting:AnAppliedApproach.Armonk,NY:M.E.
Sharpe,2006.
Adams,Marjorie.PDMAFoundationNPDBestPracticesStudy:ThePDMAFoundations
2004ComparativePerformanceAssessmentStudy(CPAS).OakRidge,NC:Product
Development&ManagementAssociation,2004.


CTL.SC0xSupplyChainAnalytics 21

InventoryManagement
Summary
Inventorymanagementisatthecoreofallsupplychainandlogisticsmanagement.Thereare
manyreasonsforholdinginventoryincludingminimizingthecostofcontrollingasystem,
bufferingagainstuncertaintiesindemand,supply,deliveryandmanufacturing,aswellas
coveringthetimerequiredforanyprocess.Havinginventoryallowsforasmootheroperation
inmostcasessinceitalleviatestheneedtocreateproductfromscratchforeachindividual
demand.Inventoryistheresultofapushsystemwheretheforecastdetermineshowmuch
inventoryofeachitemisrequired.

Thereis,however,aproblemwithhavingtoomuchinventory.Excessinventorycanleadto
spoilage,obsolescence,anddamage.Also,spendingtoomuchoninventorylimitsthe
resourcesavailableforotheractivitiesandinvestments.Inventoryanalysisisessentiallythe
determinationoftherightamountofinventoryoftherightproductintherightlocationinthe
rightform.Strategicdecisionscovertheinventoryimplicationsofproductandnetworkdesign.
Tacticaldecisionscoverdeploymentanddeterminewhatitemstocarry,inwhatform(raw
materials,workinprocess,finishedgoods,etc.),andwhere.Finally,operationaldecisions
determinethereplenishmentpolicies(whenandhowmuch)oftheseinventories.

WeseektheOrderReplenishmentPolicythatminimizesthesetotalcostsandspecificallythe
TotalRelevantCosts(TRC).Acostcomponentisconsideredrelevantifitimpactsthedecision
athandandwecancontrolitbysomeaction.AReplenishmentPolicyessentiallystatestwo
things:thequantitytobeordered,andwhenitshouldbeordered.Aswewillsee,theexact
formoftheTotalCostEquationuseddependsontheassumptionswemakeintermsofthe
situation.Therearemanydifferentassumptionsinherentinanyofthemodelswewilluse,but
theprimaryassumptionsaremadeconcerningtheformofthedemandfortheproduct
(whetheritisconstantorvariable,randomordeterministic,continuousordiscrete,etc.).

KeyConcepts
ReasonstoHoldInventory
Coverprocesstime
Allowforuncouplingofprocesses
Anticipation/Speculation
Minimizecontrolcosts
Bufferagainstuncertaintiessuchasdemand,supply,delivery,and
manufacturing.

CTL.SC0xSupplyChainAnalytics 22

InventoryDecisions
Strategicsupplychaindecisionsarelongtermandincludedecisionsrelatedto
thesupplychainsuchaspotentialalternativestoholdinginventoryandproduct
design.
Tacticalaremadewithinamonth,aquarterorayearandareknownas
deploymentdecisionssuchaswhatitemstocarryasinventory,inwhatformto
carryitemsandhowmuchofeachitemtoholdandwhere.
Operationalleveldecisionsaremadeondaily,weeklyormonthlybasisand
replenishmentdecisionssuchashowoftentoreviewinventorystatus,how
oftentomakereplenishmentdecisionsandhowlargereplenishmentshouldbe.
Thereplenishmentdecisionsarecriticaltodeterminehowthesupplychainisset
up.

InventoryClassification
Financial/AccountingCategories:RawMaterials,WorkinProgress(WIP),
Components/SemiFinishedGoodsandFinishedGoods.Thiscategorydoesnot
helpintrackingopportunitycostsandhowonemaywishtomanageinventory.
Functional(SeeFigure4):
o CycleStockAmountofinventorybetweendeliveriesorreplenishments
o SafetyStockInventorytocoverorbufferagainstuncertainties
o PipelineInventoryInventorywhenorderisplacedbuthasnotyet
arrived

Figure4.Inventorychart:Depictionoffunctionalinventoryclassifications

CTL.SC0xSupplyChainAnalytics 23

RelevantCosts
TheTotalCost(TC)equationistypicallyusedtomakethedecisionsofhowmuchinventoryto
holdandhowtoreplenish.ItisthesumofthePurchasing,Ordering,Holding,andShortage
costs.ThePurchasingcostsareusuallyvariableorperitemcostsandcoverthetotallanded
costforacquiringthatproductwhetherfrominternalmanufacturingorpurchasingitfrom
outside.

Totalcost=Purchase(UnitValue)Cost+Order(SetUp)Cost+Holding(Carrying)Cost+
Shortage(stockout)Cost
Purchase:Costperitemortotallandedcostforacquiringproduct.
Ordering:Itisafixedcostandcontainscosttoplace,receiveandprocessa
batchofgoodincludingprocessinginvoicing,auditing,labor,etc.In
manufacturingthisisthesetupcostforarun.
Holding:Costsrequiredtoholdinventorysuchasstoragecost(warehouse
space),servicecosts(insurance,taxes),riskcosts(lost,stolen,damaged,
obsolete),andcapitalcosts(opportunitycostofalternativeinvestment).
Shortage:Costsofnothavinganiteminstock(onhandinventory)tosatisfya
demandwhenitoccurs,includingbackorder,lostsales,lostcustomers,and
disruptioncosts.Alsoknownasthepenaltycost.

Acostisrelevantifitiscontrollableanditappliestothespecificdecisionbeingmade.

Notation
c: Purchasecost($/unit)
ct: OrderingCosts($/order)
h: Holdingrateusuallyexpressedasapercentage($/$value/time)
ce: ExcessholdingCosts($/unittime);alsoequaltoch
cs: Shortagecosts($/unit)
TRC: TotalRelevantCoststhesumoftherelevantcostcomponents
TC: TotalCoststhesumofallfourcostelements

EconomicOrderQuantity(EOQ)
TheEconomicOrderQuantityorEOQisthemostinfluentialandwidelyused(andsometimes
misused!)inventorymodelinexistence.Whileverysimple,itprovidesdeepandusefulinsights.
Essentially,theEOQisatradeoffbetweenfixed(ordering)andvariable(holding)costs.Itis
oftencalledLotSizingaswell.TheminimumoftheTotalCostequation(whenassuming
demandisuniformanddeterministic)istheEOQorQ*.TheInventoryReplenishmentPolicy
becomesOrderQ*everyT*timeperiodswhichunderourassumptionsisthesameasOrder
Q*whenInventoryPosition(IP)=0.

CTL.SC0xSupplyChainAnalytics 24

LikeWikipedia,theEOQisaGREATplacetostart,butnotnecessarilyagreatplacetofinish.It
isagoodfirstestimatebecauseitisexceptionallyrobust.Forexample,a50%increaseinQ
overtheoptimalquantity(Q*)onlyincreasestheTRCby~8%!

Whileveryinsightful,theEOQmodelshouldbeusedwithcautionasithasrestrictive
assumptions(uniformanddeterministicdemand).Itcanbesafelyusedforitemswithrelatively
stabledemandandisagoodfirstcutbackoftheenvelopecalculationinmostsituations.Itis
helpfultodevelopinsightsinunderstandingthetradeoffsinvolvedwithtakingcertain
managerialactions,suchasloweringtheorderingcosts,loweringthepurchaseprice,changing
theholdingcosts,etc.

EOQModel
Assumptions
o Demandisuniformanddeterministic.
o Leadtimeisinstantaneous(0)althoughthisisnotrestrictiveatallsince
theleadtime,L,doesnotinfluencetheOrderSize,Q.
o Totalamountorderedisreceived.
InventoryReplenishmentPolicy
o OrderQ*unitseveryT*timeperiods.
o OrderQ*unitswheninventoryonhand(IOH)iszero.
Essentially,theQ*istheCycleStockforeachreplenishmentcycle.Itisthe
expecteddemandforthatamountoftimebetweenorderdeliveries.

Notation
c: Purchasecost($/unit)
ct: OrderingCosts($/order)
ce: ExcessholdingCosts($/unit/time);equaltoch
cs: Shortagecosts($/unit)
D: Demand(units/time)
DA: ActualDemand(units/time)
DF: ForecastedDemand(units/time)
h: Carryingorholdingcost($/inventory$/time)
Q: ReplenishmentOrderQuantity(units/order)
Q*: OptimalOrderQuantityunderEOQ(units/order)
Q*A: OptimalOrderQuantitywithActualDemand(units/order)
Q*F: OptimalOrderQuantitywithForecastedDemand(units/order)
T: OrderCycleTime(time/order)
T*: OptimalTimebetweenReplenishments(time/order)
N: OrdersperTimeor1/T(order/time)
TRC(Q): TotalRelevantCost($/time)
TC(Q):TotalCost($/time)
Formulas
CTL.SC0xSupplyChainAnalytics 25


TotalCosts: TC=Purchase+Order+Holding+Shortage
Thisisthegenerictotalcostequation.Thespecificformofthedifferentelementsdependson
theassumptionsmadeconcerningthedemand,theshortagetypes,etc.

2

TotalRelevantCosts:TRC=Order+Holding
ThepurchasingcostandtheshortagecostsarenotrelevantfortheEOQbecausethepurchase
pricedoesnotchangetheoptimalorderquantity(Q*)andsincewehavedeterministic
demand,wewillnotstockout.

2

OptimalOrderQuantity(Q*)
RecallthatthisissimplytheFirstOrderconditionoftheTRCequationwhereitisaglobal
minimum.

OptimalTimebetweenReplenishments
RecallthatT*=Q*/D.Thatis,thetimebetweenordersistheoptimalordersizedividedbythe
annualdemand.Similarly,thenumberofreplenishmentsperyearissimplyN*=1/T*=D/Q*.
PluggingintheactualQ*givesyoutheformulabelow.

Note:BesuretoputT*intounitsthatmakesense(days,weeks,months,etc.).Dontleaveitin
years!

OptimalTotalCosts
AddingthepurchasecosttotheTRC(Q*)costsgivesyoutheTC(Q*).Westillassumenostock
outcosts.

2

OptimalTotalRelevantCosts
PluggingtheQ*backintotheTRCequationandsimplifyinggivesyoutheformulabelow.

2

CTL.SC0xSupplyChainAnalytics 26

SensitivityAnalysis
TheEOQisveryrobust.Thefollowingformulasprovidesimplewaysofcalculatingtheimpact
ofusinganonoptimalQ,anincorrectannualDemandD,oranonoptimaltimeinterval,T.

EOQSensitivitywithRespecttoOrderQuantity
Theequationbelowcalculatesthepercentdifferenceintotalrelevantcoststooptimalwhen
usinganonoptimalorderquantity(Q):

1


2

Note:Ifoptimalquantitydoesnotmakesense,itisalwaysbettertoorderlittlemorerather

orderinglittleless.

EOQSensitivitywithRespecttoDemand
Theequationbelowcalculatesthepercentdifferenceintotalrelevantcoststooptimalwhen
assuminganincorrectannualdemand(DF)wheninfacttheactualannualdemandisDA:

1

2

EOQSensitivitywithRespecttoTimeIntervalbetweenOrders
Theequationbelowcalculatesthepercentdifferenceintotalrelevantcoststooptimalwhen
usinganonoptimalreplenishmenttimeinterval(T).Thiswillbecomeveryimportantwhen
findingrealisticreplenishmentintervals.ThePowerofTwoPolicyshowsthatorderingin
incrementsof2ktimeperiods,wewillstaywithin6%oftheoptimalsolution.Forexample,if
thebasetimeperiodisoneweek,thenthePowerofTwoPolicywouldsuggestorderingevery
week(20)oreverytwoweeks(21)oreveryfourweeks(22)oreveryeightweeks(23)etc.Select
theintervalclosesttooneoftheseincrements.

1


2

EconomicOrderQuantity(EOQ)Extensions
TheEconomicOrderQuantitycanbeextendedtocovermanydifferentsituations,three
extensionsinclude:leadtime,volumediscounts,andfinitereplenishmentorEPQ.

WedevelopedtheEOQpreviouslyassumingtheratherrestrictive(andridiculous)assumption
thatleadtimewaszero.Thatis,instantaneousreplenishmentlikeonStarTrek.However,
includinganonzeroleadtimewhileincreasingthetotalcostduetohavingpipelineinventory

CTL.SC0xSupplyChainAnalytics 27

willNOTchangethecalculationoftheoptimalorderquantity,Q*.Inotherwords,leadtimeis
notrelevanttothedeterminationoftheneededcyclestock.

Volumediscountsaremorecomplicated.Includingthemmakesthepurchasingcostsrelevant
sincetheynowimpacttheordersize.Wediscussedthreetypesofdiscounts:AllUnits(where
thediscountappliestoallitemspurchasedifthetotalamountexceedsthebreakpoint
quantity),Incremental(wherethediscountonlyappliestothequantitypurchasedthatexceeds
thebreakpointquantity),andOneTime(whereaonetimeonlydiscountisofferedandyou
needtodeterminetheoptimalquantitytoprocureasanadvancebuy).Discountsare
exceptionallycommoninpracticeastheyareusedtoincentivizebuyerstopurchasemoreorto
orderinconvenientquantities(fullpallet,fulltruckload,etc.).

FiniteReplenishmentisverysimilartotheEOQmodel,exceptthattheproductisavailableata
certainproductionrateratherthanallatonce.Inthelessonweshowthatthistendstoreduce
theaverageinventoryonhand(sincesomeofeachorderismanufacturedoncetheorderis
received)andthereforeincreasestheoptimalorderquantity.
Leadtimeisgreaterthan0(ordernotreceivedinstantaneously)
o InventoryPolicy:
OrderQ*unitswhenIP=DL
OrderQ*unitseveryT*timeperiods
Discounts
o AllUnitsDiscountDiscountappliestoallunitspurchasediftotalamountexceeds
thebreakpointquantity
o IncrementalDiscountDiscountappliesonlytothequantitypurchasedthatexceeds
thebreakpointquantity
o OneTimeOnlyDiscountAonetimeonlydiscountappliestoallunitsyouorder
rightnow(noquantityminimumorlimit)
FiniteReplenishment
o InventorybecomesavailableatarateofPunits/timeratherthanallatonetime
o IfProductionrateapproachinfinity,modelconvergestoEOQ

Notation
c: Purchasecost($/unit)
ci: Discountedpurchasepricefordiscountrangei($/unit)
cei: Effectivepurchasecostfordiscountrangei($/unit)[forincrementaldiscounts]
ct: OrderingCosts($/order)
ce: ExcessholdingCosts($/unit/time);Equaltoch
cs: Shortagecosts($/unit)
cg: OneTimeGoodDealPurchasePrice($/unit)

CTL.SC0xSupplyChainAnalytics 28

Fi: FixedCostsAssociatedwithUnitsOrderedbelowIncrementalDiscount
Breakpointi
D: Demand(units/time)
DA: ActualDemand(units/time)
DF: ForecastedDemand(untis/time)
h: Carryingorholdingcost($/inventory$/time)
L: OrderLeadtime
Q: ReplenishmentOrderQuantity(units/order)
Q*: OptimalOrderQuantityunderEOQ(units/order)
Qi: Breakpointforquantitydiscountfordiscounti(unitsperorder)
Qg: OneTimeGoodDealOrderQuantity
P: Production(units/time)
T: OrderCycleTime(time/order)
T*: OptimalTimebetweenReplenishments(time/order)
N: OrdersperTimeor1/T(order/time)
TRC(Q): TotalRelevantCost($/time)
TC(Q):TotalCost($/time)

Formulas
InventoryPosition
InventoryPosition(IP)=InventoryonHand(IOH)+InventoryonOrder(IOO)BackOrders(BO)
CommittedOrders(CO)
InventoryonOrder(IOO)istheinventorythathasbeenordered,butnotyetreceived.Thisis
inventoryintransitandalsoknowsasPipelineInventory(PI).

AveragePipelineInventory
AveragePipelineInventory(API),onaverage,istheannualdemandtimestheleadtime.
Essentially,everyitemspendsLtimeperiodsintransit.

TotalCostincludingPipelineInventory
TheTCequationchangesslightlyifweassumeanonzeroleadtimeandincludethepipeline
inventory.

2

Notethatasbefore,though,thepurchasecost,shortagecosts,andnowpipelineinventoryis
notrelevanttodeterminingtheoptimalorderquantity,Q*:

CTL.SC0xSupplyChainAnalytics 29

Discounts
Ifweincludevolumediscounts,thenthepurchasingcostbecomesrelevanttoourdecisionof
orderquantity.

AllUnitsDiscounts
Discountappliestoallunitspurchasediftotalamountexceedsthebreakpointquantity.
TheprocedureforasinglerangeAllUnitsquantitydiscount(wherenewpriceisc1iforderingat
leastQ1units)isasfollows:
1. CalculateQ*C0,theEOQusingthebase(nondiscounted)price,andQ*C1,theEOQusing
thefirstdiscountedprice
2. IfQ*C1Q1,thebreakpointforthefirstallunitsdiscount,thenorderQ*C1sinceit
satisfiestheconditionofthediscount.Otherwise,gotostep3.
3. ComparetheTRC(Q*C0),thetotalrelevantcostwiththebase(nondiscounted)price,
withTRC(Q1),thetotalrelevantcostusingthediscountedprice(c1)atthebreakpointfor
thediscount.IfTRC(Q*C0)<TRC(Q1),selectQ*C0,otherwiseorderQ1.

Notethatiftherearemorediscountlevels,youneedtocheckthisforeachone.
0

0
2

Note:Allunitsdiscounttendtoraisecyclestockinthesupplychainbyencouragingretailersto
increasethesizeofeachorder.Thismakeseconomicsenseforthemanufacturer,especially
whenheincursaveryhighfixedcostperorder.

IncrementalDiscounts
Discountappliesonlytothequantitypurchasedthatexceedsthebreakpointquantity.
TheprocedureforamultirangeIncrementalquantitydiscount(whereiforderingatleastQ1
units,thenewpricefortheQQ1unitsisc1)isasfollows:
1. CalculatetheFixedcostperbreakpoint,Fi,
2. CalculatetheQ*iforeachdiscountrangei(toincludetheFi)
3. CalculatetheTRCforalldiscountrangeswheretheQi1<Q*i<Qi+1,thatis,ifitisin
range.
4. SelectthediscountthatprovidesthelowestTRC.

Theeffectivecost,cei,canbeusedfortheTRCcalculations.
0 ;

CTL.SC0xSupplyChainAnalytics 30

OneTimeDiscount
Thisisalesscommondiscountbutitdoeshappen.Aonetimeonlydiscountappliestoall
unitsyouorderrightnow(nominimumquantityorlimit).
SimplycalculatetheQ*gandthatisyourorderquantity.IfQ*g=Q*thenthediscountdoesnot
makesense.IfyoufindthatQ*g<Q*,youmadeamathematicalmistakecheckyourwork!

2

2
2


FiniteReplenishmentorEconomicProductionQuantity
OnecanthinkoftheEPQequationsasgeneralizedformswheretheEOQisaspecialcasewhere
P=infinity.Astheproductionratedecreases,theoptimalquantitytobeorderedincreases.
However,notethatifP<D,thismeanstherateofproductionisslowerthantherateofdemand
andthatyouwillneverhaveenoughinventorytosatisfydemand.
1

2
2

1 1

SinglePeriodInventoryModels
Thesingleperiodinventorymodelissecondonlytotheeconomicorderquantityinits
widespreaduseandinfluence.AlsoreferredtoastheNewsvendor(Newsboy)model,the
singleperiodmodeldiffersfromtheEOQinthreemainways.First,whiletheEOQassumes
uniformanddeterministicdemand,thesingleperiodmodelallowsdemandtobevariableand
stochastic(random).Second,whiletheEOQassumesasteadystatecondition(stabledemand
withessentiallyaninfinitetimehorizon),thesingleperiodmodelassumesasingleperiodof
time.Allinventoriesmustbeorderedpriortothestartofthetimeperiodandtheycannotbe
replenishedduringthetimeperiod.Anyinventoryleftoverattheendofthetimeperiodis
scrappedandcannotbeusedatalatertime.Ifthereisextrademandthatisnotsatisfied

CTL.SC0xSupplyChainAnalytics 31

duringtheperiod,ittooislost.Third,forEOQweareminimizingtheexpectedcosts,whilefor
thesingleperiodmodelweareactuallymaximizingtheexpectedprofitability.

Aplannedbackorderiswherewestockoutonpurposeknowingthatcustomerswillwait,
althoughwedoincurapenaltycost,cs,forstockingout.Fromthis,wedeveloptheideaofthe
criticalratio(CR),whichistheratioofthecs(thecostofshortageorhavingtoolittleproduct)to
theratioofthesumofcsandce(thecostofhavingtoomuchoranexcessofproduct).The
criticalratio,bydefinition,rangesbetween0and1andisagoodmetricoflevelofservice.A
highCRindicatesadesiretostockoutlessfrequently.TheEOQwithplannedbackordersis
essentiallythegeneralizedformwherecsisessentiallyinfinity,meaningyouwillneverever
stockout.Ascsgetssmaller,theQ*PBOgetslargerandalargerpercentageisallowedtobe
backorderedsincethepenaltyforstockingoutgetsreduced.

Thecriticalratioappliesdirectlytothesingleperiodmodelaswell.Weshowthattheoptimal
orderquantity,Q*,occurswhentheprobabilitythatthedemandislessthanQ*=theCritical
Ratio.Inotherwords,theCriticalRatiotellsmehowmuchofthedemandprobabilitythat
shouldbecoveredinordertomaximizetheexpectedprofits.

MarginalAnalysis:SinglePeriodModel
Twocostsareassociatedwithsingleperiodproblems
Excesscost(ce)whenD<Q($/unit)i.e.toomuchproduct
Shortagecost(cs)whenD>Q($/unit)i.e.toolittleproduct
Ifweassumecontinuousdistributionofdemand
ceP[XQ]=expectedexcesscostoftheQthunitordered
cs(1P[XQ])=expectedshortagecostoftheQthunitordered

ThisimpliesthatifE[ExcessCost]<E[ShortageCost]thenincreaseQandthatweareatQ*
whenE[ShortageCost]=E[ExcessCost].Solvingthisgivesus:
Inwords,thismeansthatthepercentageofthedemanddistributioncoveredbyQshouldbe
equaltotheCriticalRatioinordertomaximizeexpectedprofits.

Notation
B: Penaltyfornotsatisfyingdemandbeyondlostprofit($/unit)
b: BackorderDemand(units)
b*: Optimalunitsonbackorderwhenplacinganorder(unit)
c: Purchasecost($/unit)
ct: OrderingCosts($/order)
ce: ExcessholdingCosts($/unit/time);Equaltoch
cs: ShortageCosts($/unit)
D: AverageDemand(units/time)
g: Salvagevalueforexcessinventory($/unit)
h: Carryingorholdingcost($/inventory$/time)

CTL.SC0xSupplyChainAnalytics 32

L: ReplenishmentLeadTime(time)
Q: ReplenishmentOrderQuantity(units/order)

Q : OptimalOrderQuantitywithPlannedbackorders
T: OrderCycleTime(time/order)
TRC(Q): TotalRelevantCost($/time)
TC(Q): TotalCost($/time)

Formulas

EOQwithPlannedBackorders
ThisisanextensionofthestandardEOQwiththeabilitytoallowforbackordersatapenaltyof
cs.
,
2 2


2
1

OrderQ whenIOH=b*;OrderQ everyT timeperiods

SinglePeriod(Newsvendor)Model
Tomaximizeexpectedprofitability,weneedtoordersufficientinventory,Q,suchthatthe
probabilitythatthedemandislessthanorequaltothisamountisequaltotheCriticalRatio.
Thus,theprobabilityofstockingoutisequalto1CR.

Forthesimplestcasewherethereisneithersalvagevaluenorextrapenaltyofstockingout,
thesebecome:
cs=pc,thatisthelostmarginofmissingapotentialsaleand,
ce=c,thatis,thecostofpurchasingoneunit.
TheCriticalRatiobecomes: whichissimplythemargindividedby
theprice!

Whenweconsideralsosalvagevalue(g)andshortagepenalty(B),thesebecome:

CTL.SC0xSupplyChainAnalytics 33

cs=pc+B,thatisthelostmarginofmissingapotentialsaleplusapenaltyperitem
shortand
ce=cg,thatis,thecostofpurchasingoneunitminusthesalvagevalueIcangainback.
Nowthecriticalratiobecomes

SinglePeriodInventoryModelsExpectedProfitability
Weexpandouranalysisofthesingleperiodmodeltobeabletocalculatetheexpected
profitabilityofagivensolution.Inthepreviouslesson,welearnedhowtodeterminethe
optimalorderquantity,Q*,suchthattheprobabilityofthedemanddistributioncoveredbyQ*
isequaltotheCriticalRatio,whichistheratiooftheshortagecostsdividedbythesumofthe
shortageandexcesscosts.

Inordertodeterminetheprofitabilityforasolution,weneedtocalculatetheexpectedunits
sold,theexpectedcostofbuyingQunits,andtheexpectedunitsshort,E[US].Calculatingthe
E[US]istricky,butweshowhowtousetheNormalTablesaswellasspreadsheetstodetermine
thisvalue.

Notation
B: Penaltyfornotsatisfyingdemandbeyondlostprofit($/unit)
c: Purchasecost($/unit)
ct: OrderingCosts($/order)
ce: ExcessholdingCosts($/unit);Forsingleperiodproblemsthisisnotnecessarily
equaltoch,sincethatassumesthatyoucankeeptheinventoryforlateruse.
cs: ShortageCosts($/unit)
D: AverageDemand(units/time)
g: Salvagevalueforexcessinventory($/unit)
k: SafetyFactor
x: UnitsDemanded
E[US]:ExpectedUnitsShort(units)
Q: ReplenishmentOrderQuantity(units/order)
TRC(Q): TotalRelevantCost($/period)
TC(Q): TotalCost($/period)

Formulas
ProfitMaximization
Inwords,theexpectedprofitfororderingQunitsisequaltothesalesprice,p,timesthe
expectednumberofunitssold,E[x]),minusthecostofpurchasingQunits,cQ,minusthe
expectednumberofunitsIwouldbeshorttimesthesalesprice.Thedifficultpartofthis
equationistheexpectedunitsshort,ortheE[US].
CTL.SC0xSupplyChainAnalytics 34

ExpectedProfitswithSalvageandPenalty
Ifweincludeasalvagevalue,g,andashortagepenalty,B,thenthisbecomes:




Rearrangingthisbecomes:

Inwords,theexpectedprofitfororderingQunitsisequaltofourterms.Thefirsttermisthe
salesprice,p,timestheexpectednumberofunitssold,E[x]),minustheexpectedunitsshort.
ThesecondtermissimplythecostofpurchasingQunits,cQ.Thethirdtermistheexpected
numberofitemsthatIwouldhaveleftoverforsalvage,timesthesalvagevalue,g.The
fourthandfinaltermistheexpectednumberofunitsshorttimestheshortagepenalty,B.

ExpectedValues
E[UnitsDemanded]
Continuous: Discrete:

E[UnitsSold]
Continuous: Discrete:


E[UnitsShort]
Continuous: Discrete:

CTL.SC0xSupplyChainAnalytics 35

ExpectedUnitsShortE[US]
Thisisatrickyconcepttogetyourheadaroundatfirst.ThinkoftheE[US]astheaverage
(meanorexpectedvalue)ofthedemandABOVEsomeamountthatwespecifyorhaveon
hand.AsmyQgetslarger,thenweexpecttheE[US]togetsmaller,sinceIwillprobablynot
stockoutasmuch.

Luckilyforus,wehaveanicewayofcalculatingtheE[US]fortheNormalDistribution.The
ExpectedUnitNormalLossFunctionisnotedasG(k).Tofindtheactualunitsshort,we
simplymultiplythisG(k)timesthestandarddeviationoftheprobabilitydistribution.

YoucanusetheNormaltablestofindtheG(k)foragivenkvalueoryoucanuse
spreadsheetswiththeequationbelow:
, 0,1,0 1

ProbabilisticInventoryModels
Wedevelopinventoryreplenishmentmodelswhenwehaveuncertainorstochasticdemand.
WebuiltoffofboththeEOQandthesingleperiodmodelstointroducethreegeneralinventory
policies:theBaseStockPolicy,the(s,Q)continuousreviewpolicyandthe(R,S)periodicreview
policy(theR,Smodelwillbeexplainedinthenextlesson).Thesearethemostcommonlyused
inventorypoliciesinpractice.TheyareimbeddedwithinacompanysERPandinventory
managementsystems.

Toputthemincontext,hereisthesummaryofthefiveinventorymodelscoveredsofar:
EconomicOrderQuantityDeterministicDemandwithinfinitehorizon
o OrderQ*everyT*periods
o OrderQ*whenIP=DL
SinglePeriod/NewsvendorProbabilisticDemandwithfinite(singleperiod)horizon
o OrderQ*atstartofperiodwhereP[xQ]=CR
BaseStockPolicyProbabilisticDemandwithinfinitehorizon
o Essentiallyaoneforonereplenishment
o Orderwhatwasdemandedwhenitwasdemandedinthequantityitwas
demanded
ContinuousReviewPolicy(s,Q)ProbabilisticDemandwithinfinitehorizon
o Thisiseventbasedweorderwhen,andif,inventorypassesacertainthreshold
o OrderQ*whenIPs
PeriodicReviewPolicy(R,S)ProbabilisticDemandwithinfinitehorizon
o Thisisatimebasedpolicyinthatweorderonasetcycle
o OrderuptoSunitseveryRtimeperiods

CTL.SC0xSupplyChainAnalytics 36


Allofthemodelsmaketradeoffs:EOQbetweenfixedandvariablecosts,Newsvendor
betweenexcessandshortageinventory,andthelatterthreebetweencostandlevelofservice.
Theconceptoflevelofservice,LOS,isoftenmurkyandspecificdefinitionsandpreferencesvary
betweenfirms.However,forourpurposes,wecanbreakthemintotwocategories:targets
andcosts.Wecanestablishatargetvalueforsomeperformancemetricandthendesignthe
minimumcostinventorypolicytoachievethelevelofservice.Thetwometricscoveredare
CycleServiceLevel(CSL)andItemFillRate(IFR).Thesecondapproachistoplaceadollar
amountonaspecifictypeofstockoutoccurringandthenminimizethetotalcostfunction.The
twocostmetricswecoveredwereCostofStockOutEvent(CSOE)andCostofItemShort(CIS).
Theyarerelatedtoeachother.

Regardlessofthemetricsused,theendresultisasafetyfactor,k,andasafetystock.The
safetystockissimplykDL.ThetermDLisdefinedasthestandarddeviationofdemandover
leadtime,butitismoretechnicallytherootmeansquareerror(RMSE)oftheforecastoverthe
leadtime.Mostcompaniesdonottracktheirforecasterrortothegranularlevelthatyou
requireforsettinginventorylevels,sodefaultingtothestandarddeviationofdemandisnot
toobadofanestimate.Itisessentiallyassumingthattheforecastisthemean.

Notation
B1: Costassociatedwithastockoutevent($/event)
c: Purchasecost($/unit)
ct: OrderingCosts($/order)
ce: ExcessholdingCosts($/unit/time);Equaltoch
cs: Shortagecosts($/unit)
D: AverageDemand(units/time)
DS: Demandovershorttimeperiod(e.g.week)
DL: Demandoverlongtimeperiod(e.g.month)
h: Carryingorholdingcost($/inventory$/time)
L: ReplenishmentLeadTime(time)
Q: ReplenishmentOrderQuantity(units/order)
T: OrderCycleTime(time/order)
DL: ExpectedDemandoverLeadTime(units/time)
DL: StandardDeviationofDemandoverLeadTime(units/time)
k: SafetyFactor
s: ReorderPoint(units)
S: OrderuptoPoint(units)
R: ReviewPeriod(time)
N: OrdersperTimeor1/T(order/time)
IP: InventoryPosition=InventoryonHand+InventoryonOrderBackorders
IOH: InventoryonHand(units)
IOO: InventoryonOrder(units)
IFR: ItemFillRate(%)
CTL.SC0xSupplyChainAnalytics 37

CSL: CycleServiceLevel(%)
CSOE: CostofStockOutEvent($/event)
CIS: CostperItemShort
E[US]: ExpectedUnitsShort(units)
G(k): UnitNormalLossFunction

Formulas
BaseStockPolicy
TheBaseStockpolicyisaoneforonepolicy.IfIsellfouritems,Iorderfouritemsto
replenishtheinventory.Thepolicydetermineswhatthestockinglevel,orthebasestock,is
foreachitem.Thebasestock,S*,isthesumoftheexpecteddemandovertheleadtime
plustheRMSEoftheforecasterroroverleadtimemultipliedbysomesafetyfactork.The
LOSforthispolicyissimplytheCriticalRatio.Notethattheexcessinventorycost,ce,inthis
case(andallmodelshere)assumesyoucanuseitlaterandistheproductofthecostandthe
holdingrate,ch.
OptimalBaseStock,S*: S k
LevelofService(LOS): LOS=P[DLS*]=CR=

ContinuousReviewPolicies(s,Q)
ThisisalsoknownastheOrderPoint,OrderQuantitypolicyandisessentiallyatwobin
system.ThepolicyisOrderQ*unitswhenInventoryPositionislessthanthereorderpoint
s.ThereorderpointisthesumoftheexpecteddemandovertheleadtimeplustheRMSE
oftheforecasterroroverleadtimemultipliedbysomesafetyfactork.
ReorderPoint:
OrderQuantity(Q): QistypicallyfoundthroughtheEOQformula

LevelofServiceMetrics
Herearefourmethodsfordeterminingtheappropriatesafetyfactor,k,foruseinanyofthe
inventorymodels.TheyareCycleServiceLevel,CostperStockOutEvent,ItemFillRate,and
CostperItemShort.

CTL.SC0xSupplyChainAnalytics 38

CycleServiceLevel(CSL)
TheCSListheprobabilitythattherewillnotbeastockoutwithinareplenishmentcycle.
Thisisfrequentlyusedasaperformancemetricwheretheinventorypolicyisdesignedto
minimizecosttoachieveanexpectedCSLof,say,95%.Thus,itisoneminustheprobability
ofastockoutoccurring.IfIknowthetargetCSLandthedistribution(wewilluseNormal
mostofthetime)thenwecanfindthesthatsatisfiesitusingtablesoraspreadsheetwhere
s=NORMINVDIST(CSL,Mean,StandardDeviation)andk=NORMSINV(CSL).
CSL 1 P Stockout 1 PX s PX s

Notethataskincreases,itgetsdifficulttoimproveCSLanditwillrequireenormous
amountofinventorytocovertheextremelimits.

CostPerStockoutEvent(CSOE)orB1Cost
TheCSOEisrelatedtotheCSL,butinsteadofdesigningtoatargetCSLvalue,apenaltyis
chargedwhenastockoutoccurswithinareplenishmentcycle.Theinventorypolicyis
designedtominimizethetotalcostssothisbalancescostofholdinginventoryexplicitly
withthecostofstockingout.Minimizingthetotalcostsfork,wefindthataslongas
>1,thenweshouldset:

2 ln
2
If <1,weshouldsetkaslowasmanagementallows.

ItemFillRate(IFR)
TheIFRisthefractionofdemandthatismetwiththeinventoryonhandoutofcyclestock.
Thisisfrequentlyusedasaperformancemetricwheretheinventorypolicyisdesignedto
minimizecosttoachieveanexpectedIFRof,say,90%.IfIknowthetargetIFRandthe
distribution(wewilluseNormalmostofthetime)thenwecanfindtheappropriatekvalue
byusingtheUnitNormalLossFunction,G(k).
1 1

1
G(k)istheUnitNormalLossFunction,whichcanbecalculatedinSpreadsheetsas
, 0,1,0 1

Oncewefindthekusingunitnormaltables,wecanplugthevaluesin
toframethepolicy.

CTL.SC0xSupplyChainAnalytics 39

CostperItemShort(CIS)
TheCISisrelatedtotheIFR,butinsteadofdesigningtoatargetIFRvalue,apenaltyis
chargedforeachitemshortwithinareplenishmentcycle.Theinventorypolicyisdesigned
tominimizethetotalcostssothisbalancescostofholdinginventoryexplicitlywiththe
costofstockingout.Minimizingthetotalcostsfork,wefindthataslongas 1,then
weshouldfindksuchthat:

Otherwise,weshouldsetkaslowasmanagementallows.Inaspreadsheet,this
becomesk=NORMSINV(1 )

SummaryoftheMetricsPresented
Metric Howtofindk

%ServiceBased CycleServiceLevel(CSL) K=NORMSINV(1 PX s )


%ServiceBased ItemFillRate(IFL) Findkfrom 1
$CostBased CostperStockOutEvent(CSOE)
2 ln
2
$CostBased CostperItemShort(CIS) K=NORMSINV(1 )
Table2.Summaryofmetricspresented

ATiponConvertingTimes
Youwilltypicallyneedtoconvertannualforecaststoweeklydemandorviceversaor
somethinginbetween.Thisisgenerallyveryeasybutsomestudentsgetconfusedattimes:

Convertinglongtoshort(nisnumberofshortperiodswithinlong):
/
/
/
Convertingfromshorttolong:


PeriodicReviewPolicies
Therearetradeoffsbetweenthedifferentperformancemetrics(bothcostandservicebased).
Wedemonstratethatonceoneofthemetricsisdetermined(orexplicitlyset)thentheother
threeareimplicitlyset.Becausetheyallleadtotheestablishmentofasafetyfactor,k,theyare

CTL.SC0xSupplyChainAnalytics 40

dependentoneachother.Thismeansthatonceyouhavesetthesafetystock,regardlessofthe
method,youcancalculatetheexpectedperformanceimpliedbytheremainingthreemetrics.

PeriodicReviewpoliciesareverypopularbecausetheyfittheregularpatternofworkwhere
orderingmightoccuronlyonceaweekoronceeverytwoweeks.Theleadtimeandthereview
periodarerelatedandcanbetradedofftoachievecertaingoals.

Notation
B1: Costassociatedwithastockoutevent
c: Purchasecost($/unit)
ct: OrderingCosts($/order)
ce: ExcessholdingCosts($/unit/time);Equaltoch
cs: Shortagecosts($/unit)
cg: OneTimeGoodDealPurchasePrice($/unit)
D: AverageDemand(units/time)
h: Carryingorholdingcost($/inventory$/time)
L: ReplenishmentLeadTime(time)
Q: ReplenishmentOrderQuantity(units/order)
T: OrderCycleTime(time/order)
DL: ExpectedDemandoverLeadTime(units/time)
DL: StandardDeviationofDemandoverLeadTime(units/time)
DL+R: ExpectedDemandoverLeadTimeplusReviewPeriod(units/time)
DL+R: StandardDeviationofDemandoverLeadTimeplusReviewPeriod(units/time)
k: SafetyFactor
s: ReorderPoint(units)
S: OrderuptoPoint(units)
R: ReviewPeriod(time)
N: OrdersperTimeor1/T(order/time)
IP: InventoryPosition=InventoryonHand+InventoryonOrderBackorders
IOH: InventoryonHand(units)
IOO: InventoryonOrder(units)
IFR: ItemFillRate(%)
CSL: CycleServiceLevel(%)
CSOE: CostofStockOutEvent($/event)
CIS: CostperItemShort
E[US]: ExpectedUnitsShort(units)
G(k): UnitNormalLossFunction

Formulas
InventoryPerformanceMetrics
Safetystockisdeterminedbythesafetyfactor,k.Sothat: andtheexpected
costofsafetystock= .

CTL.SC0xSupplyChainAnalytics 41

Twowaystocalculatek:ServicebasedorCostbasedmetrics:

ServiceBasedMetricssetktomeetexpectedlevelofservice
o CycleServiceLevel( )
o ItemFillRate( 1 )
Note:IFRisalwayshigherthanCSLforthesamesafetystocklevel.

CostBasedMetricsfindkthatminimizestotalcosts
o CostperStockoutEvent(E CSOE )

o CostperItemsShort( )

SafetyStockLogicrelationshipbetweenperformancemetrics
Therelationshipbetweenthefourmetrics(2costand2servicebased)isshowninthe
flowchartbelow(Figure5).Onceonemetric(CSL,IFR,CSOE,orCIS)isexplicitlyset,thenthe
otherthreemetricsareimplicitlydetermined.


Figure5.Relationshipamongthefourmetrics

PeriodicReviewPolicy(R,S)
ThisisalsoknownastheOrderUpTopolicyandisessentiallyatwobinsystem.Thepolicyis
OrderUpToS*unitseveryRtimeperiods.ThismeanstheorderquantitywillbeS*IP.The
orderuptopoint,S*,isthesumoftheexpecteddemandovertheleadtimeandthe

CTL.SC0xSupplyChainAnalytics 42

replenishmenttimeplustheRMSEoftheforecasterroroverleadplusreplenishmenttime
multipliedbysomesafetyfactork.
OrderUpToPoint:

Periodic(R,S)versusContinuous(s,Q)Review
Thereisaconvenienttransformationof(s,Q)to(R,S)
o (s,Q)=Continuous,orderQwhenIPs
o (R,S)=Periodic,orderuptoSeveryRtimeperiods
Allowsfortheuseofallprevious(s,Q)decisionrules
o Reorderpoint,s,forcontinuousbecomesOrderUpTopoint,S,forperiodic
system
o QforcontinuousbecomesD*Rforperiodic
o LforacontinuousbecomesR+Lforperiodic
Approach
o Maketransformations
o Solvefor(s,Q)usingtransformations
o Determinefinalpolicysuchthat
(s,Q) (R,S)
s S
Q D*R
L R+L

RelationshipBetweenL&R
Theleadtime,L,andthereviewperiod,R,bothinfluencethetotalcosts.Notethattheaverage
inventorycostsfora(R,S)systemis .ThisimpliesthatincreasingLead
Time,L,willincreaseSafetyStocknonlinearlyandPipelineInventorylinearlywhileincreasing
theReviewPeriod,RwillincreasetheSafetyStocknonlinearlyandtheCycleStocklinearly.

InventoryModelsforMultipleItems&Locations
Thereareseveralproblemswithmanagingitemsindependently,including:
Lackofcoordinationconstantlyorderingitems
Ignoringofcommonconstraintssuchasfinancialbudgetsorspace
Missedopportunitiesforconsolidationandsynergies
Wasteofmanagementtime

ManagingMultipleItems
Therearetwoissuestosolveinordertomanagemultipleitems:
1. CanweaggregateSKUstousesimilaroperatingpolicies?
a. Groupusingcommoncostcharacteristicsorbreakpoints
b. GroupusingPowerofTwoPolicies
2. Howdowemanageinventoryundercommonconstraints?

CTL.SC0xSupplyChainAnalytics 43

a. Exchangecurvesforcyclestock
b. Exchangecurvesforsafetystock

AggregationMethods
WhenwehavemultipleSKUstomanage,wewanttoaggregatethoseSKUswherewecanuse
thesamepolicies.

GroupingLikeItemsBreakPoints
BasicIdea:Replenishhighervalueitemsfaster
Usedforsituationswithmultipleitemsthathave
o Relativelystabledemand
o Commonorderingcosts,ct,andholdingcharges,h
o Differentannualdemands,Di,andpurchasecostci
Approach
o Pickabasetimeperiod,w0,(typicallyaweek)
o Createasetofcandidateorderingperiods(w1,w2,etc.)
o FindDicivalueswhereTRC(wj)=TRC(wj+1)
o GroupSKUsthatfallincommonvalue(Dici)buckets

PowerofTwoFormula
Orderintimeintervalsofpowersoftwo
Selectarealisticbaseperiod,Tbase(day,week,month)
GuaranteesthatTRCwillbewithin6%ofoptimal!

ManagingUnderCommonConstraints
Thereistypicallyabudgetorspaceconstraintthatlimitstheamountofinventorythatyoucan
actuallykeeponhand.Managingeachinventoryitemseparatelycouldleadtoviolatingthis
constraint.Exchangecurvesareagoodwaytousethemanagerialleversofholdingcharge,
orderingcost,andsafetyfactortosetinventorypoliciestomeetacommonconstraint.

ExchangeCurves:CycleStock
HelpsdeterminethebestallocationofinventorybudgetacrossmultipleSKUs
RelevantCostparameters
o HoldingCharge(h)
Thereisnosinglecorrectvalue
Costallocationsfortimeandsystemsdifferbetweenfirms
Reflectionofmanagementsinvestmentandriskprofile
o OrderCost(ct)
Notknowwithprecision
Costallocationsfortimeandsystemsdifferbetweenfirms
ExchangeCurve
o Depictstradeoffbetweentotalannualcyclestock(TACS)andnumberof
replenishments(N)
o Determinesthect/hvaluethatmeetsbudgetconstraints
CTL.SC0xSupplyChainAnalytics 44


ExchangeCurves:SafetyStock
Needtotradeoffcostofsafetystockandlevelofservice
Keyparameterissafetyfactor(k)usuallysetbymanagement
Estimatetheaggregateservicelevelfordifferentbudgets
Theprocessisasfollows:
1. Selectaninventorymetrictotarget
2. Startingwithahighmetricvaluecalculate:
a. TherequiredkitomeetthattargetforeachSKU
b. TheresultingsafetystockcostforeachSKUandthetotalsafetystock
(TSS)
c. TheotherresultinginventorymetricsofinterestforeachSKUandtotal
3. Lowerthemetricvalue,gotostep2
4. ChartresultingTSSversusInventoryMetrics

ManagingMultipleLocations
Managingthesameiteminmultiplelocationswillleadtoahigherinventorylevelthan
managingtheminasinglelocation.Consolidatinginventorylocationstoasinglecommon
locationisknownasinventorypooling.Poolingreducesthecyclestockneededbyreducingthe
numberofdeliveriesrequiredandreducesthesafetystockbyriskpoolingthatreducestheCV
ofthedemand.Thisisalsocalledthesquarerootlawwhichisinsightfulandpowerful,but
alsomakessomerestrictiveassumptions,suchasuniformlydistributeddemand,useofEOQ
orderingprinciples,andindependenceofdemandindifferentlocations.

Notation
ci: Purchasecostforitemi($/unit)
ct: OrderingCosts($/order)
ce: ExcessholdingCosts($/unit/time);Equaltoch
cs: Shortagecosts($/unit)
Di: AverageDemandforitemi(units/time)
h: Carryingorholdingcost($/inventory$/time)
Q: ReplenishmentOrderQuantity(units/order)
T: OrderCycleTime(time/order)
TPractical:PracticalOrderCycleTime(time/order)
k: SafetyFactor
w0: BaseTimePeriod(time)
s: ReorderPoint(units)
R: ReviewPeriod(time)
N: NumberofInventoryReplenishmentCycles
TACS: TotalAnnualCycleStock
TSS: TotalValueofSafetyStock
TVIS: TotalValueofItemsShort
G(k): UnitNormalLossFunction

CTL.SC0xSupplyChainAnalytics 45


Formulas
PowerofTwoPolicy
Theprocessisasfollows:
1. CreatetableofSKUs
2. CalculateT*foreachSKU
3. CalculateTpracticalforeachSKU

2


2


/
2
Inaspreadsheetthisis:Tpractical=2^(ROUNDUP(LN(Toptimal/SQRT(2))/LN(2)))

ExchangeCurves:CycleStock


Process
1. CreateatableofSKUswithAnnualValue(Dici)and D c
2. Findthesumof D c termforSKUsbeinganalyzed
3. CalculateTACSandNforrangeof(ct/h)values
4. ChartNvsTACS

ExchangeCurves:SafetyStock

Process:
1. Selectaninventorymetrictotarget
2. Startingwithahighmetricvaluecalculate:
a. TherequiredkitomeetthattargetforeachSKU
b. TheresultingsafetystockcostforeachSKUandthetotalsafetystock
(TSS)
c. TheotherresultinginventorymetricsofinterestforeachSKUandtotal
3. Lowerthemetricvalue,gotostep2
4. ChartresultingTSSversusInventoryMetrics

CTL.SC0xSupplyChainAnalytics 46


PooledInventories

Chart1.Comparisonbetweenindependentandpooledinventories

InventoryModelsforClassA&CItems

InventoryManagementbySegment
AItems BItems CItems
TypeofRecords Extensive,Transactional Moderate Noneusearule
LevelofManagement Frequent(Monthlyor Infrequently OnlyasAggregate
Reporting More) Aggregated
InteractionwithDemand DirectInput,HighData ModifiedForecast SimpleForecastatBest
Integrity,Manipulate (promotions,etc.)
(pricing,etc.)
InteractionwithSupply ActivelyManage ManagebyException Non
InitialDeployment MinimizeExposure(high SteadyState SteadyState
v)
FrequencyofPolicy VeryFrequent(Monthly Moderate VeryInfrequent
Review orMore) (Annually/EventBased)
ImportanceofParameter VeryHighAccuracy ModerateRounding VeryLow
Precision Worthwhile andApproximationok
ShortageStrategy ActivelyManage SetServiceLevel& Set&ForgetServiceLevels
(Confront) ManagebyException
DemandDistribution ConsiderAlternativesto Normal N/A
NormalasSituationFits
ManagementStrategy Active Automatic Passive
Table3.Inventorymanagementbysegment

CTL.SC0xSupplyChainAnalytics 47

InventoryPolicies(RulesofThumb)
TypeofItem ContinuousReview PeriodicReview
AItems (s,S) (R,s,S)
BItems (s,Q) (R,S)
CItems Manual~(R,S)
Table4.Inventorypolicies(rulesofThumb)

ManagingClassAItems
TherearetwogeneralwaysthatitemscanbeconsideredClassA:
FastMovingbutCheap(LargeD,SmallcQ>1)
SlowMovingbutExpensive(Largec,SmallDQ=1
ThisdictateswhichProbabilityDistributiontouseformodelingthedemand
FastMovers
o NormalorLognormalDistribution
o GoodenoughforBitems
o OKforAitemsifDLorDL+R10
SlowMovers
o PoissonDistribution
o Morecomplicatedtohandle
o OKforAitemsifDLorDL+R<10

ManagingClassCItems
ClassCitemshavelowcDvaluesbutcomprisethelionshareoftheSKUs.Whenmanaging
themweneedtoconsidertheimplicit&explicitcosts.Theobjectiveistominimize
managementattention.Regardlessofpolicy,savingswillmostlikelynotbesignificant,sotryto
designsimplerulestofollowandexploreopportunitiesfordisposingofinventory.
Alternatively,trytosetcommonreorderquantities.Thiscanbedonebyassumingcommonct
andhvaluesandthenfindingDicivaluesfororderingfrequencies.

DisposingofExcessInventory
Whydoesexcessinventoryoccur?
o SKUportfoliostendtogrow
o PoorforecastsShorterlifecycles
Whichitemstodispose?
o LookatDOS(daysofsupply)foreachitem=IOH/D
o ConsidergettingridofitemsthathaveDOS>xyears
Whatactionstotake?
o Converttootheruses
o Shiptomoredesiredlocation
o Markdownprice
o Auction

CTL.SC0xSupplyChainAnalytics 48

RealWorldInventoryChallenges
Whilemodelsareimportant,itisalsoimportanttounderstandwheretherearechallenges
implementingmodelsinreallife.
Modelsarenotusedexactlyasintextbooks
Dataisnotalwaysavailableorcorrect
Technologymatters
Businessprocessesmatterevenmore
Inventorypoliciestrytoanswerthreequestions:
o HowoftenshouldIcheckmyinventory?
o HowdoIknowifIshouldordermore?
o Howmuchtoorder?
Allinventorymodelsusetwokeynumbers
o InventoryPosition
o OrderPoint

Notation
B1: CostAssociatedwithaStockoutEvent
c: PurchaseCost($/unit)
ct: OrderingCosts($/order)
ce: ExcessHoldingCosts($/unit/time);Equaltoch
cs: ShortageCosts($/unit)
cg: OneTimeGoodDealPurchasePrice($/unit)
D: AverageDemand(units/time)
h: CarryingorHoldingCost($/inventory$/time)
L[Xi]: DiscreteUnitLossFunction
Q: ReplenishmentOrderQuantity(units/order)
T: OrderCycleTime(time/order)
DL: ExpectedDemandoverLeadTime(units/time)
DL: StandardDeviationofDemandoverLeadTime(units/time)
DL+R: ExpectedDemandoverLeadTimeplusReviewPeriod(units/time)
DL+R: StandardDeviationofDemandoverLeadTimeplusReviewPeriod(units/time)
k: SafetyFactor
s: ReorderPoint(units)
S: OrderUptoPoint(units)
R: ReviewPeriod(time)
N: OrdersperTimeor1/T(order/time)
IP: InventoryPosition=InventoryonHand+InventoryonOrder(IOO)Backorders
IOH: InventoryonHand(units)
IOO: InventoryonOrder(units)
IFR: ItemFillRate(%)
CSL: CycleServiceLevel(%)
E[US]: ExpectedUnitsShort(units)
G(k): UnitNormalLossFunction

CTL.SC0xSupplyChainAnalytics 49


Formulas

FastMovingAItems

2

1


2 ln
2
Iterativelysolvethetwoequations
StopwhenQ*andk*convergewithinacceptablerange

SlowMovingAItems
UseaPoissondistributiontomodelsales
Probabilityofxeventsoccurringwithinatimeperiod
Mean=Variance=


!
Foradiscretefunction,thelossfunctionL[Xi]canbecalculatedasfollows(Cachon&
Terwiesch)
1

LearningObjectives
Understandthereasonsforholdinginventoryandthedifferenttypesofinventory.
Understandtheconceptsoftotalcostandtotalrelevantcosts.
Identifyandquantifythefourmajorcostcomponentsoftotalcosts:Purchasing,
Ordering,Holding,andShortage.
AbletoestimatetheEconomicOrderQuantity(EOQ)andtodeterminewhenitis
appropriatetouse.
AbletoestimatesensitivityofEOQtounderlyingchangesintheinputdataand
understandingofitsunderlyingrobustness.

CTL.SC0xSupplyChainAnalytics 50

UnderstandhowtodeterminetheEOQwithdifferentvolumediscountingschemes.
UnderstandhowtodeterminetheEconomicProductionQuantity(EPQ)whenthe
inventorybecomesavailableatacertainrateoftimeinsteadofallatonce.
AbilitytousetheCriticalRatiotodeterminetheoptimalorderquantitytomaximize
expectedprofits.
AbilitytoestablishedinventorypoliciesforEOQwithplannedbackordersaswellas
singleperiodmodels.
Abilitytodetermineprofitability,expectedunitsshort,expectedunitssoldofasingle
periodmodel.
Understandingofsafetystockanditsroleinprotectingforexcessdemandoverlead
time.
Abilitytodevelopbasestockandorderpoint,orderquantitycontinuousreviewpolicies.
Abilitytodeterminepropersafetyfactor,k,giventhedesiredCSLorIFRorthe
appropriatecostpenaltyforCSOEorCIS.
Abletoestablishaperiodicreview,OrderUpTo(S,R)ReplenishmentPolicyusinganyof
thefourperformancemetrics.
Understandrelationshipsbetweentheperformancemetrics(CSL,IFR,CSOE,andCIS)
andbeabletocalculatetheimplicitvalues.
Abletousetheinventorymodelstomaketradeoffsandestimateimpactsofpolicy
changes.
UnderstandhowtousedifferentmethodstoaggregateSKUsforcommoninventory
policies.
UnderstandhowtouseExchangeCurves.
Understandhowinventorypoolingimpactsbothcyclestockandsafetystock.
UnderstandhowtousedifferentinventorymodelsforClassAandCitems.

References
ForGeneralInventoryManagement
Therearemorebooksthatcoverthebasicsofinventorymanagementthantherearegrainsof
sandonthebeach!InventorymanagementisalsousuallycoveredinOperationsManagement
andIndustrialEngineeringtextsaswell.Awordofwarning,though.Everytextbookuses
differentnotationforthesameconcepts.Getusedtoit.Alwaysbesuretounderstandwhat
thenomenclaturemeanssothatyoudonotgetconfused.
Nahmias,S.ProductionandOperationsAnalysis.McGrawHillInternationalEdition.
ISBN:00722312653.Chapter4.
Silver,E.A.,Pyke,D.F.,Peterson,R.InventoryManagementandProductionPlanningand
Scheduling.ISBN:9780471119470.Chapter1
Ballou,R.H.BusinessLogisticsManagement.ISBN:9780130661845.Chapter9.
CTL.SC0xSupplyChainAnalytics 51

ForEOQ
Schwarz,LeroyB.,TheEconomicOrderQuantity(EOQ)ModelinBuildingintuition:
insightsfrombasicoperationsmanagementmodelsandprinciples,editedbyDilip
Chhajed,TimothyLowe,2007,Springer,NewYork,(pp135154).
Silver,E.A.,Pyke,D.F.,Peterson,R.InventoryManagementandProductionPlanningand
Scheduling.ISBN:9780471119470.Chapter5
Ballou,R.H.BusinessLogisticsManagement.ISBN:9780130661845.Chapter9.

ForEOQExtensions
Nahmias,S.ProductionandOperationsAnalysis.McGrawHillInternationalEdition.
ISBN:00722312653.Chapter4.
Silver,E.A.,Pyke,D.F.,Peterson,R.InventoryManagementandProductionPlanningand
Scheduling.ISBN:9780471119470.Chapter5.
Ballou,R.H.BusinessLogisticsManagement.ISBN:9780130661845.Chapter9.
Schwarz,LeroyB.,TheEconomicOrderQuantity(EOQ)ModelinBuildingintuition:
insightsfrombasicoperationsmanagementmodelsandprinciples,editedbyDilip
Chhajed,TimothyLowe,2007,Springer,NewYork,(pp135154).
Muckstadt,JohnandAmarSapra"ModelsandSolutionsinInventoryManagement".,
2006,SpringerNewYork,NewYork,NY.Chapter2&3.

ForSinglePeriodInventoryModels
Nahmias,S.ProductionandOperationsAnalysis.McGrawHillInternationalEdition.
ISBN:00722312653.Chapter5.
Silver,E.A.,Pyke,D.F.,Peterson,R.InventoryManagementandProductionPlanningand
Scheduling.ISBN:9780471119470.Chapter10.
Porteus,EvanL.,TheNewsvendorProbleminBuildingintuition:insightsfrombasic
operationsmanagementmodelsandprinciples,editedbyDilipChhajed,TimothyLowe,
2007,Springer,NewYork,(pp115134).
Muckstadt,JohnandAmarSapra"ModelsandSolutionsinInventoryManagement".,
2006,SpringerNewYork,NewYork,NY.Chapter5.
Ballou,R.H.BusinessLogisticsManagement.ISBN:9780130661845.Chapter9.

ForProbabilisticInventoryModels
Nahmias,S.ProductionandOperationsAnalysis.McGrawHillInternationalEdition.
ISBN:00722312653.Chapter5.
Silver,E.A.,Pyke,D.F.,Peterson,R.InventoryManagementandProductionPlanningand
Scheduling.ISBN:9780471119470.Chapter7.
Ballou,R.H.BusinessLogisticsManagement.ISBN:9780130661845.Chapter9.
Muckstadt,JohnandAmarSapra"ModelsandSolutionsinInventoryManagement".,
2006,SpringerNewYork,NewYork,NY.Chapter9,10

ForInventoryModelswithMultipleItemsandLocations
Silver,E.A.,Pyke,D.F.,Peterson,R.InventoryManagementandProductionPlanningand
Scheduling.ISBN:9780471119470.Chapter7&8.

CTL.SC0xSupplyChainAnalytics 52


ForInventoryModelsforClassA&ClassCItems
Cachon,Gerard,andChristianTerwiesch.MatchingSupplywithDemand:An
IntroductiontoOperationsManagement.Boston,MA:McGrawHill/Irwin,2005.
Silver,E.A.,Pyke,D.F.,Peterson,R.InventoryManagementandProductionPlanningand
Scheduling.ISBN:9780471119470.Chapter8&9.

CTL.SC0xSupplyChainAnalytics 53

FundamentalsofFreightTransportation
Summary
Thefundamentalsoffreighttransportationprovidesandoverviewofdifferentmodesof
transportationandsomedifferentwaystomakedecisionsofthemodechoice,analyzingthe
tradeoffsbetweencostandlevelofservice.

Therearedifferentlevelsoftransportationnetworks(fromstrategictophysical).Physical
networkrepresentshowtheproductphysicallymoves,theactualpathfromoriginto
destination.Costsanddistancescalculationsaremadebasedonthislevel.Decisionsfrom
nodes(decisionpoints)andarcs(aspecificmode)aremadeintheOperationalnetwork.The
thirdnetwork,thestrategicorservicenetwork,representsindividualpathsfromendtoend,
andthosedecisionsthattieintotheinventorypoliciesaremadeintheStrategicorService
networklevel.Forinstance,howroutingdecisionstietoTotalRelevantCosts(TRC)isshown.

Freighttransportationalsoincludestheimportantcomponentofpackaging.ThePrimary
packaging,hasdirectcontactwiththeproductandisusuallythesmallestunitofdistribution
(e.g.abottleofwine,acan,etc.).TheSecondarypackagingcontainsproductandalsoamiddle
layerofpackagingthatisoutsidetheprimarypackaging,mainlytogroupprimarypackages
together(e.g.aboxwith12bottleofwines,cases,cartons,etc.).TheTertiarypackagingis
designedthinkingmoreontransportshipping,warehousestorageandbulkhandling(e.g.
pallets,containers,etc.).

KeyConcepts
TradeoffsbetweenCostandLevelofService(LOS):
ProvidespathviewoftheNetwork
Summarizesthemovementincommonfinancialandperformanceterms
Usedforselectingoneoptionfrommanybymakingtradeoffs

Packaging
Levelofpackagingmirrorshandlingneeds
Palletsstandardsizeof48x40inintheUSA(120x80cminEurope)
ShippingContainers
o TEU(20ft)33m3volumewith24.8kkgtotalpayload
o FEU(40ft)67m3volumewith28.8kkgtotalpayload
o 53ftlong(DomesticUS)111m3volumewith20.5kkgtotalpayload

CTL.SC0xSupplyChainAnalytics 54

TransportationNetworks
PhysicalNetwork:Theactualpaththattheproducttakesfromorigintodestination
includingguideways,terminalsandcontrols.Basisforallcostsanddistancecalculations
typicallyonlyfoundonce.
OperationalNetwork:Theroutetheshipmenttakesintermsofdecisionpoints.Eacharc
isaspecificmodewithcosts,distance,etc.Eachnodeisadecisionpoint.Thefour
primarycomponentsareloading/unloading,localrouting,linehaul,andsorting.
StrategicNetwork:Aseriesofpathsthroughthenetworkfromorigintodestination.
Eachrepresentsacompleteoptionandhasendtoendcost,distance,andservice
characteristics.

Notation
TL:Truckload
TEU:TwentyFootEquivalent(cargocontainer)
FEU:FortyFootEquivalent(cargocontainer)

LeadTimeVariability&ModeSelection
Variabilityintransittimeimpactsthetotalcostequationforinventory.Thereareimportant
linkagesbetweentransportationreliability,forecastaccuracy,andinventorylevels.Mode
selectionisheavilyinfluencednotonlybythevalueoftheproductbeingtransported,butalso
theexpectedandvariabilityoftheleadtime.

ImpactonInventory
Transportationaffectstotalcostvia
Costoftransportation(fixed,variable,orsomecombination)
Leadtime(expectedvalueaswellasvariability)
Capacityrestrictions(astheylimitoptimalordersize)
Miscellaneousfactors(suchasmaterialrestrictionsorperishability)

TransportationCostFunctions
Transportationcostscantakemanydifferentforms,toinclude:
Purevariablecost/unit
Purefixedcost/shipment
Mixedvariable&fixedcost
Variablecost/unitwithaminimumquantity
Incrementaldiscounts

Lead/TransitTimeReliability
Therearetwodifferentdimensionsofreliabilitythatdonotalwaysmatch:
Credibility(reserveslotsareagreed,stopatallports,loadallcontainers,etc.)

CTL.SC0xSupplyChainAnalytics 55

Scheduleconsistency(actualvs.quotedperformance)

Contractreliabilityinprocurementandoperationsdonotalwaysmatchastheyaretypically
performedbydifferentpartsofanorganization.Contractreliabilitydiffersdramaticallyacross
differentroutesegments(originportdwellvs.porttoporttransittimevs.destinationport
dwellforinstance).Formostshippers,themosttransitvariabilityoccursintheorigininland
transportationlegsandattheports.

ModeSelection
Transportationmodeshavespecificnichesandperformbetterthanothermodesincertain
situations.Also,inmanycases,thereareonlyoneortwofeasibleoptionsbetweenmodes.

CriteriaforFeasibility
Geography
o Global:AirversusOcean(truckscannotcrossoceans!)
o Surface:Trucking(TL,LTL,parcel)vs.Railvs.Intermodalvs.Barge
Requiredspeed
o >500milesin1dayAir
o <500milesin1dayTL
Shipmentsize(weight/density/cube,etc.)
o Highweight,cubeitemscannotbemovedbyair
o Largeoversizedshipmentsmightberestrictedtorailorbarge
Otherrestrictions
o Nuclearorhazardousmaterials(HazMat)
o Productcharacteristics

Tradeoffswithinthesetoffeasiblechoices
Onceallfeasiblemodes(orseparatecarrierfirms)havebeenidentified,theselectionwithin
thisfeasiblesetismadeasatradeoffbetweencosts.Itisimportanttotranslatethenon
costelementsintocostsviathetotalcostequation.Thetypicalnoncostelementsare:
Time(meantransittime,variabilityoftransittime,frequency)
Capacity
LossandDamage

CTL.SC0xSupplyChainAnalytics 56

Notation
ci: Purchasecostforitemi($/unit)
ct: OrderingCosts($/order)
ce: ExcessholdingCosts($/unit/time);Equaltoch
cs: Shortagecosts($/unit)
D: AverageDemand(units/time)
h: Carryingorholdingcost($/inventory$/time)
Q: ReplenishmentOrderQuantity(units/order)
T: OrderCycleTime(time/order)
D: ExpectedDemand(Items)duringOneTimePeriod
D: StandardDeviationofDemand(Items)duringOneTimePeriod
L: ExpectedNumberofTimePeriodsforLeadTime(UnitlessMultiplier)
L: StandardDeviationofTimePeriodsforLeadTime(UnitlessMultiplier)
DL: ExpectedDemand(Items)overLeadTime
DL: StandardDeviationofDemand(Items)overLeadTime
N: RandomVariableAssumingPositiveIntegerValues(1,2,3)
xi: IndependentRandomVariablessuchthatE[xi]=E[X]
S: Sumofxifromi=1toN

Formulas

RandomSumsofRandomVariables


LeadTimeVariability

OnetoManyDistribution
Onemethodtoquicklyapproximatecostsofacomplicatedtransportationsystemistheoneto
manydistribution.Themainideaistodevelopaverysimpleapproximatetotalcostequation

CTL.SC0xSupplyChainAnalytics 57

usingaslittledataaspossible.Thisapproachcanbeverypowerfulforinitialanalysis.Also,it
hasbeenshowntobemorerobustthansomemoredetailedanalysessincetheseother
methodsrequireveryrestrictiveassumptions.

DistributionMethods
Onetoone:directorpointtopointmovementsfromorigintodestination
Onetomany:multistopmovesfromasingleorigintomanydestinations
Manytomany:movingfrommultipleoriginstomultipledestinationsusuallywithahub
orterminal

OnetoManySystem
SingleDistributionCenter
o Productsoriginatefromoneorigin
o Productsaredemandedatmanydestinations
o AlldestinationsarewithinaspecifiedServiceRegion
o Ignoreinventory(samedaydelivery)
Assumptions:
o Vehiclesarehomogenous
o Samecapacity,QMAX
o Fleetsizeisconstant
Findingtheestimatedtotaldistance:
o DividetheServiceRegionintoDeliveryDistricts
o Estimatethedistancerequiredtoserviceeachdistrict
Routetoserveaspecificdistrict:
o Linehaulfromorigintothe1stcustomerinthedistrict
o Localdeliveryfrom1sttolastcustomerinthedistrict
o Backhaul(empty)fromthelastcustomertotheorigin

Notation
dLineHaul: DistancefromOrigintoCenterofGravity(Centroid)ofDeliveryDistrict
dLocal: LocalDeliverybetweencCustomersinOneDistrict
kcf: CircuityFactor
l: NumberofTours
c: NumberofCustomerStopperTour
n: TotalNumberofStops(=c*l)
LATi: LatitudeofPointiinRadians
LONGi: LongitudeofPointiinRadians
Radians:(AngleinDegrees)*(/180)
A: AreaofDistrict
: Density(NumberofStops/Area)
dTSP: TravelingSalesmanDistance
dStop: AverageDistanceperStop

CTL.SC0xSupplyChainAnalytics 58

kTSP: TravelingSalesmanFactor(Unitless)
E[n]: ExpectedNumberofStopsinaDistrict
E[D]: ExpectedDemandinaDistrict
QMAX: CapacityofEachTruck
cs: CostperStop($/Stop)
cd: Costperdistance($/Mile)
cvs: CostperUnitperStop($/ItemMile)
N: RandomVariableAssumingPositiveIntegerValues(1,2,3)
Xi: IndependentRandomVariablessuchthatE[Xi]=E[X]
S: SumofXifromi=1toN

Formulas
DistanceEstimation:PointtoPoint
EuclideanSpace:
Grid: | | | |
RandomNetwork:
Forshortdistances,
Forlongdistanceswithinthesamehemisphere(greatcircleequation)
3959 arccos sin sin
cos cos


OnetoManySystem

CTL.SC0xSupplyChainAnalytics 59


EstimatingTourDistance
2
2

2


Minimizethenumberoftoursbymaximizingvehiclecapacity



2




OnetoManySystem
Expecteddistanceforalltours
1
2 2
2
Expecteddistanceforalltoursifeachdistricthasadifferentdensity
1
2
2



TotalTransportCost
1 1
2
2 2



LearningObjectives
Understandcommonterminologyandconceptsofglobalfreighttransportation.
Understandingofphysical,operational,andstrategicnetworks.
AbilitytoselectmodebytradingoffLevelofService(LOS)andcost.
Understandtheimpactoftransportationoncycle,safety,andpipelinestock.
Understandhowthevariabilityoftransportationtransittimeimpactsinventory
Understandthedifferentdistributiontypes:onetoone,onetomany,andmanyto
many.

CTL.SC0xSupplyChainAnalytics 60

Abletousecontinuousapproximationtomakequickestimatesofcostsusingaminimal
amountofdata.
Abletoestimatedistancesfordifferentunderlyingnetworktopologies.

References
Ballou,RonaldH.,BusinessLogistics:SupplyChainManagement,3rdedition,Pearson
PrenticeHall,2003.Chapter6.
Chopra,SunilandPeterMeindl,SupplyChainManagement,Strategy,Planning,and
Operation,5thedition,PearsonPrenticeHall,2013.Chapter14.

For One to Many Distribution


Daganzo,Carlos,LogisticsSystemsAnalysis,4thedition,SpringerVerlag,2004.

CTL.SC0xSupplyChainAnalytics 61