A

PRESENTATION
ON

Aggregate Inventory Management

&
Distribution inventory management

Presented By :
Priyanka Gupta
( 2010PMM124 )
Anupama Kumari
( 2009PMM119 )
Inventory & Flow of Materials

vRaw materials
vWork-in-process (WIP)
vRaw and in-process (RIP)
vFinished goods
vDistribution inventories
vMaintenance, repair, & operational supplies
(MROs)
v
 Inventory Objectives

Inventories must be coordinated to meet

three conflicting objectives:
–Maximize customer service
–Minimize plant operation costs
–Minimize inventory investment
 Inventory Costs
Inventory management costs
–Item costs
–Carrying costs
–Ordering costs
–Stock out costs
–Capacity-related costs
 Functions of Inventories
ØMeet anticipated demand
ØSmooth production requirements
ØDecouple components of production
distribution system
ØProtect against stock outs (provide customer
service)
ØTake advantage of order cycles
ØHedge against price increases
ØExploit quantity discounts
ØPermit operations
 Aggregate Inventory
Management
ØAggregate inventory management (AIM) is
concerned with managing inventories according to
their classifications (raw material, work-in-
process, finished goods, etc.) & the function they
perform.
ØAIM is financially oriented & concerned with costs
& benefits of carrying the classifications of
inventories
 Aggregate Inventory
Management
AIM involves
–Flow & kind of inventory needed
–Supply & demand patterns
–Functions inventory performs
–Objectives of inventory management
–Costs associated with inventory
 LOT SIZE INVENTORY
MANAGEMENT INTERPOLATION
TECHNIQUES (LIMIT)

It is a technique developed for handling

EOQ’s in a aggregate and dealing with the
problem of constraint of EOQ equation. It provides
a means to calculate directly the proper lot size for
a family of items to meet some constraints.
Then LIMIT order quantities are calculated
with the help of formulas A & B
 FORMULA
LIMIT formula A =


 IL= IT(HL/HT)2
LIMIT formula B =


 M=HT/HL=√(IT/IL)
Where
HL=Di*hi/QLi=Total set up hours for present LIMITorder

quantities.
HT=Di*hi/QTi=Total set up hours for trial order quantities.

IT = Inventory carrying cost for trial order quantities.

IL = Inventory carrying cost used for LIMIT order quantities.


 Example 1
 Suppose that D=10000, S=$125, I=0.25,
C=$10, what is the trial lot size? If we were limited
to 5 setup in the year, find M with the help of LIMIT
formula.


Solution:
QT= √(2DS/Ic)

 = √(2*10000*125/0.25*10)
 =1000
Setup in the year=

 D/Q=10



 limited setup in the year=5
ØD/QL=5
ØQL=2000
Ø QL= √(2DS/ILc)
 = √(2*10000*125/IL*10)=2000
Ø IL=6.25%
Relationship between the trial and the LIMIT lot

size
Ø QL=M*QT

Where M= √(IT/IL)
Ø 2000=M*1000
Ø M=2
 Example-2
The two item in our inventory have been managed in a “seat of
the pants” fashion for several years. The following table shows
the current situation:


Item

Annual Setup Unit Cost Present Yearly Setup
A

Usage ‘D’
10000 2Hours per 10
of item ‘c’ Order
769 Hours ’H’
26

B 5000 order
3 ’h’ 15 Quantity
1667 9

Total ’Q’ 35


Current setup costs=$62.50 per hour

Carrying cost percentage= IT=35%

How can this situation be handled using LIMIT?

Yearly limited Setup Hours ’H’
HP=Di *hi/QPi

For A, HP=(10000*2/769)=26

For B, HP=(5000*3/1667)=9

Total HP=35hours,

Cost per Setup ‘S’

For A=$62.50*2=$125.00

For B=$62.50*3=$187.50

Trial lot size QT=√(2DS/Ic)

For A=√{(2*10000*125)/(0.35*10)}=845

For B=√{(2*5000*187)/(0.35*15)}=598
 Approximate Yearly Setup Hours ‘HT’
HT=Di *hi/QTi

For A, HT=(10000*2/845)=24

For B, HT=(5000*3/598)=25

Item

Cost per Setup Trial Q Approximate Yearly Setup
A ‘S’
$125.0 845 Hours ‘HT’
24
B $187.5 598 25
Total

49


M=HT/HL=1.4
QL=M*QT

=1.4*QT


 This leads us directly to the LIMIT order quantities:



Item
 LMIT Quantity ‘QL’ Approximately Yearly Setup
A 1.4*845=1183 Hours
17 ‘HL’
B 1.4*598=837 18
Total 35


Inventory LIMIT carrying percentage

IL= IT(HL/HT)2


=0.35(35/49)2=0.1786

 Based on this implied carrying cost
percentage of 17.86%, we calculate the Total
Relevant Cost in the table with the help of these
formulas:-

ØAnnual holding cost= (Q/2)*ILc

ØAnnual ordering cost= (D/Q)S
Ø
ØTRC=annual holding cost+annual ordering cost
TRC=(Q/2)h+(D/Q)S
 Lot size Annual Holding Annual Setup Cost Total
QP-A 769 Cost ($)
687 ($)
1625 Relevant
2312
QP-B 1667 2233 563 Costs
2796 ($)
Total 2920 2188 5108
QT-A 845 755 1479 2234
QT-B 598 801 1568 2369
Total 1556 3047 4603
QL-A 1183 1057 1057 2114
QL-B 837 1120 1120 2240
Total 2177 2177 4354
  Exchange curve
 Optimal,given I=35%
Aggregate Annual Setup Cost ($)

Aggregate Annual Holding Cost ($)

 Lagrange Multipliers
The method of Lagrange multipliers provides a
strategy for finding the maxima and minima of
a function subject to constraints.
It gives a set of necessary conditions to identify
optimal points of equality constrained optimization
problems.
This is done by converting a constrained problem
to an equivalent unconstrained problem with the
help of certain unspecified parameters known as
Lagrange multipliers.

19
 consider the optimization problem
maximize f(x,y)
subject to g(x,y)=c.
the Lagrange function defined by
L(x,y,λ)=f(x,y)+λ*{g(x,y)-c}

Figure 2: Contour map of Figure 1. The red line

Figure 1: Find x and y to maximize f(x,y) subject shows the constraint g(x,y) = c. The blue lines
to a constraint (shown in red) g(x,y) = c. are contours of f(x,y). The point where the red
line tangentially touches a blue contour is our
solution.
Lagrange multiplier technique:-


Ø L(x,y,λ)=f(x,y)+λg(x,y)(the Lagrange function)

Ø Lx=fx+λgx=0 ………(1)
Ø λ=-(fx/gx)
Ø Ly=fy+λgy=0 ………(2)
Ø λ=-(fy/gy)
Ø Lλ=g(x,y)=0 ………(3)


eq. (1) & (2) gives the slope condition:

Ø fx/gx=fy/gy
Ø fx/fy=gx/gy =dx/dy
eq. (3) provides satisfaction of the constraints.
 Example-3
 Solve the following problem
using the Lagrange multiplier method:
Suppose that we have a profit function:-
Max f(x,y)=x+3y


Subject to g(x,y)=x2+y2-10=0
 Solution
Examine the profit line:
Ø π=x+3y
In terms of y

Ø y=(π/3)-(1/3)x
Ø slope=-1/3
Ø dy/dx=-1/3
Ø
also g(x,y) solve in terms of x

Ø y 2 =10-x 2
Ø y=√10-x 2
Ø dy/dx=-(x/y)
equating the slope of the profit line and the
constraint line gives
Ø -(1/3)=-(x/y)
Ø y=3x; but y2=10-x2
Ø x=1 and y=3
Conclusion:-profit are maximized at (x,y)=(1,3)

with profit of x+3y=10.



Apply the Lagrange multiplier technique:-



Ø L(x,y,λ)=x+3y-λ(x2+y2-10)
Ø Lx=1-2λx=0
Ø Ly=3-2λy=0
Ø Lλ=x2+y2-10=0

solve for λ:
Ø λ=(1/2x)=(3/2y)
Ø y=3x
also y=√10-x 2

Ø 3x=√10-x 2
Ø x=1, y=3


gives profit


Ø f(1,3)=1+3*3=10
Ø
Ø
Ø
 Example-4
 Applying the Lagrange multiplier technique
in example-3 and specify the minimization from the
total setup cost & inventory holding costs.


Solution:-
for minimize the total setup costs

Ø (D1S1/Q1)+(D2S2/Q2)
=(10000*125/Q1)+(5000*187.5/Q2)
subject to an inventory investment constraint

Ø Q1*(I c1)/2+ Q2*(I c2)/2 =2920


 Q1*0.1786*10/2+ Q2*0.1786*15/2=2920


apply Lagrange functiona

L=(D1S1/Q1)+(D2S2/Q2)+λ[Q1*(I c1)/2+ Q2*(I c2)/2]

diff with respect to Q1,Q2 andλ we obtain

δL/ δQ1= D1S1/Q1^2+(λ I c1)/2=0

δL/ δQ2= D2S2/Q2^ 2+(λ I c2)/2=0

δL/ δ λ=Q1*(I c1)/2+ Q2*(I c2)/2=2920

solve eq we obtain
λ=0.555

Q1=1587

Q2=1122
minimum value of inventory holding costs as


Ø Q1*h1/2+ Q2*h2/2
Ø =(1587*10*0.1786)/2+(1122*15*0.1786)/2
Ø =2920


setup cost are



Ø (D1S1/Q1)+(D2S2/Q2)
Ø =10000*125/1587+5000*187.50/1122
Ø =1624
 Distribution inventory
management
 Reality customers are not conveniently located
next to the factory.
 Often inventory must stored in several locations.
 The main issues are :
1. Where to have warehouses and what to stock.
2. How to replace stocks, given the answer to the
first issue.
Multi location inventories
Multi location system
absorbent system
 Multi location system
Coalescent systems: have material coming together into one end
item.
Series system : have locations feeding each other in a direct path.
 Measures of multi location inventory
system
• Fill rate : fill rate or percent unit service, gives the average
fraction of unit demand satisfied from stock on hand.
• Fills: number of unit demanded and satisfied per unit time.
 Fills =fill rate * demand
• Expected number of backorder: is the time weighted average
number of backorders outstanding at a stocking location.
Including times of zero backorders, this measures depends
on fill rate.
Expected number of backorder=

 expected delay*demand rate

• Expected delay : average time necessary to satisfy a unit of
demand .
• Inventory holding cost.
• Setup costs and ordering costs.
• Stockout cost.
• System stability costs : cost associated with
overreaction to changes demand rates.
Example:-
D(annual demand)=1000unit
Q(order quantity)=100unit
B(maximum back order)=10unit
what is the expected number of back orders.

Solution:
Average back order position=

B/2=10/2=5unit
Percentage time when back orders are

possible =B/Q=10/100= 0.1

expected number of back orders=

(B/Q)*(B/2)=0.1*5=0.5unit
Example:-
D(annual demand)=1000unit
Q(order quantity)=100unit
B(maximum back order)=50unit , what is the
expected delay or the average time to satisfy a unit
demand. Working days=250

Demand rate(d)=1000/250=4units /
day
Expected delay=[(B/Q)*(B/2)]/d

 =[(50/100)*(50/2)]/4
 =3.125days

 Centralization of inventories
• Order decision rules and safety stock rules together to
demonstrate their combined pressure to centralize
inventories.
TRC=(DS/Q)+(Qh/2)+h(SS)

D=annual demand
S=setup cost

Q=ordered quantity

h=holding cost/unit/year.

σ= standard deviation of lead time.

k= number of standard deviation of lead time
demand used to determine safety stock.
SS= safety stock.

TRC=total relevant cost.

SS=kσ

Q=√(2DS/h)

TRC=√(2ShD)+hkσ


N=stocking point.
Di=annual demand.

σi=standard deviation

The decentralized relevant cost would be

N

∑ √Di )} + {hk ∑ σi}

N
TRC={√(2Sh
i =1
i =1


 Assuming that h and k , we could centralize these

inventories at one location. Ignoring transportation costs,
the total relevant costs would be
TRC=√(2Sh)√D+hkσ where

 =√(N
) ≤ ∑
N
√Di
D ∑D
i =1
i
i= 1

Example: two inventory locations have annual demands and costs shown.
S h D k σ √D
100 10 1000 1.64 50 31.62
100 10 2000 1.64 50 44.72

The decentralized system is given by

N N
TRC={√(2Sh
∑i= 1 √Di)} + {hk∑i= 1 σi}
TRC ={√(2*100*10(√1000+√2000))} + {10*1.64(50+50)}

 =5054
The centralized system is given by

TRC=√(2Sh)√Di+hkσ

σ = √( σ1 *σ1 + σ2 *σ2 ) =70.7

TRC ={√(2*100*10(√3000))} + {10*1.64(70.7)}

 =3609
Distribution inventory
system
 Level decompositon systems
Set aggregate service level objectives for all items at an
echelon.
e.g. The objectives at the main distribution center might

be 95% service, interpreted as a 95% fill rate. With

‘n’ items in the inventory, the problem can be stated
as follows:
minimize n (unit value on the item i)(safety stock on
∑
the item i)
i =1

Subjected to (item demand rate/aggregate demand

n

∑
rate)(item fill rate)≥0.95
i=1
 Multiechelon systems
• Sometimes called Differentiated distribution or
item decomposition systems, focus on
effective safety stock.
• Applied to low demand rate items because
mathematics of system is complex.
 One origin with several
destination


Destination



Origin
 Several origins with one
destination
 Origins


 Destination
 Several origins each with
several destination

Origins
destination


• Multiple origins and multiple

destinations.
• When multiple sources shipment to several
destinations, however solving these problem
becomes hopelessly difficult to solve
• This type of problem becomes
manageable if we assume that all
origins ship their products to a
single consolidated terminal and
that all items are distributed to
destination as demanded from the
consolidated terminal.
 Several origins with a
consolidation terminal to
several destination
 Origins
destination


 consolidated
 terminal
 Algorithm for solving
problems
• Formulas: S ic (
j k

∑∑d ijk )×50


j k

∑∑ p d
Qic=
k ijk

I( j k
)

∑∑d ijk


S ck (
i k

∑∑ d ijk )×50
i k i k
I (∑∑ p d / ∑∑ d

ijk ijk
)
k


Qcj =
where j

∑d ijkk
dijk= quantity of demand from origin i for destination j for product

Pk= price/unit of k

Di,k= demand at source ifor item k from all destinations j=

Sic= cost of load from source i to consolidation terminal c



Sck = cost of load from consolidation terminal c to destinations k

Wic=capacity of vehicle from source i to consolidation terminal c

Wck=capacity of vehicle from consolidation terminal c to destinations k

Tic=lead time/travel time from source i to consolidation terminal c

Tck=lead time/travel time from consolidation terminal c to destinations k

Fic= total quantity of items flowing per period from source i to consolidation
j k
terminal
∑∑d ijk
 =
Fck= total quantity of items flowing per period from consolidation terminal c to

destinations
i k k
 = ∑∑d ijk


I = inventory carrying percentage.

The shipping quantity from source i to consolidation terminal c is given by sic

 min[Qic,Wic]
The shipping quantity from consolidation terminal c to destinations is given by scj

 min[Qcj,Wcj]
Qic =economical shipment quantity from source i to consolidated terminal c.

Qcj = economical shipment quantity from consolidated terminal c to destination j.




 Example: The demand for the products at destination 1 and 2 and
source of these are presented in the table. The capacity of
vehicles, relevant setup costs, lead time between locations, and
other pertinent data in tables.
Assume that the inventory carrying charges amount to 20% and
that the firm operates fifty periods (weeks) per year.
Find the economical quantity to ship from each source to the
terminal and from the terminal each destination.
Destination demand and origin capacity
demand / period at

Product Cost per unit Destination1 Destination2 Source

20 8 4 1location
2 25 6 10 1
3 25 5 8 2
4 30 6 8 2
Setup cost, vehicle cost, and lead time


data
From Source 1 Source 2 Terminal Terminal
to terminal terminal destination destinatio
Setup 45 25 1
30 n2
35
cost
Vehicle 150 200 150 100
capacity
Lead time 4 2 3 4
(days)
Solution: economical quantity to ship from each
source to the terminal.
Step1:calculate the total annual demand for items 1 and 2
formula=[
∑∑d ] *50
j k

ijk

[8+6+4+10]*50=1400unit Eq1
Step2:calculate the average cost per part at source1.

Formula= j k j k

∑ ∑p d / ∑ ∑ d k ijk ijk

[(12*20)+(16*25)]/28=22.86 $ Eq2
Step3: Calculate the economical shipment quantity flowing from

source 1 to the consolidated terminal.

Qic=√[{ *50 }/{I( )}] Eq3 j k j k

∑∑ p d /∑∑d
j k

S (∑∑d )
Q1c=√[(45*1400)/(0.20*22.86)]=118unit
ic ijk k ijk ijk

Find the minimum of Q1c and W1c.

sic=min[118,150]=118unit


Step5: calculate the quantities of individual items 1 and 2
flowing from origin 1 to the consolidated terminal.
Q1c1=(
d )
j j k
( s ×∑
1c d )/∑
1 j1 ∑ ijk
 =(118*12)/28=51unit
Q1c2=(118*16)/28=67unit

Step6: repeat the calculation for source 2. following the same

procedure, we obtain the quantities of individual items 3 and 4

flowing from 2 to the consolidated terminal.
 Q2c=78unit W2c=200
 s2c=min[78,200]=78unit
Q2c3= (78*13)/27=38unit

Q2c4=(78*14)/27=40unit
The same procedure can be followed to obtain the shipment
quantities from the consolidation terminal to destination 1 and
2, respectively.
Step1: calculate the total annual demand for all items at

destination1.
[ i k
]*50
∑∑d ijk
[8+6+5+6]*50=1250unit

Step2:calculate the average cost per part at destination 1.

[ ]
i k i k

∑∑p d / ∑∑d
[(20*8)+(25*6)+(25*5)+(30*6)]/25=24.6$
k ijk ijk

Step3:calculate the economical shipment quantity for the total

flow from the consolidation terminal to destination.

Qcj= √[{ }/{I( )}]
i k i k i k

S (∑∑d ) ×50 ck ∑∑ p d / ∑∑d ijk k ijk ijk

Qc1= √[(30*1250)/(0.2*24.6)]=87.3
Step4: find minimum of Qc1 and Wc1

sc1=min[87.3,150]=87.3unit

Step5:calculate the quantities of individual items 1 through 4

flowing the consolidated terminal to terminal 1.

Qc11=(sc1 i i k
)
× ∑d i11) /( ∑∑d i1k
 =(88*8)/25=28unit
Qc12=(88*6)/25=21unit

Qc13=(88*5)/25=18unit

Qc14=(88*6)/25=21unit

Step6:repeat the calculation for destination 2. following the same

procedure, we obtain the quantities of items 1 through 4 from

the consolidation terminal to terminal2.
Qc2= 102unit
Sc2=min[102,100]=100unit

i i k
Qc21= (sc2 ))
×∑d ) /( ∑∑d
i 21 i 2k
 =(100*4)/30=13unit
Qc22 =(100*10)/30=33unit

Qc23 =(100*8)/30=27unit

Qc24 =(100*8)/30=27unit


 References
• PRODUCTION,PLANNING AND
INVENTORY CONTROL
 --S.L. NARASIMHAN
 --D.W. McLEAVEY
 --P.J. BILLINGTON
 (PRENTICE HALL OF INDIA
PRIVATE LIMITED)

Thank you