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Chap 03
Copyright 2001
Supply
Inventory & warehousing costs Production/ Transportati Transportati purchase on on costs costs Inventory & costs warehousing costs
Inventory (1/2)
Where do we hold inventory?
Suppliers and manufacturers warehouses and distribution centers retailers
Types of Inventory
WIP raw materials finished goods
Inventory (2/2)
Why do we hold inventory?
Uncertainty in customer demand
short life cycle implies that historical data may not be available many competing products in the marketplace
Uncertainty in quantity and quality of the supply, supplier costs, and delivery times Economies of scale offered by transportation companies
Understanding Inventory
The inventory policy is affected by:
Demand Characteristics: known in advance or random Lead Time Number of Different Products Stored in the Warehouse Length of Planning Horizon Objectives
Service level Minimize costs
Cost Structure
Cost Structure
order costs:
cost of product transportation costs
holding costs:
tax insurance obsolescence opportunity cost
Question
How many, when to order?
EOQ:Total Cost*
10 6 10 4 10 2 Cost 10 0 8 0 6 0 4 0 2 0 0 0 50 0 O e Q a tity rd r u n 10 00 10 50
2.5% 0.5%
80 00 10 00 0
12 00 0
14 00 0
16 00 0
Sales
18 00 0
Swimsuit Costs
Production cost per unit (C): $80 Selling price per unit (S): $125 Salvage value per unit (V): $20 Fixed production cost (F): $100,000 Q is production quantity, D: demand Revenue - Variable Cost - Fixed Cost + Salvage
Profit =
Swimsuit Scenarios
Scenario One:
Suppose you make 12,000 jackets and demand ends up being 13,000 jackets.
Profit
Scenario Two:
Suppose you make 12,000 jackets and demand ends up being 11,000 jackets.
Profit = 125(11,000) - 80(12,000) - 100,000 + 20(1000) = $ 335,000
What to Make?
Average demand is 13,100 Look at marginal cost Vs. marginal profit
if extra jacket sold, profit is 125-80 = 45 if not sold, cost is 80-20 = 60
12000
16000
20000
Order Quantity
12000
16000
20000
Order Quantity
12000
16000
20000
Order Quantity
Probability of Outcomes
10 0%
Probability
8% 0 6% 0 4% 0 2% 0 0 %
-3 0 0 0 0 0 -1 0 0 0 0 0 1 0 0 0 0 0 3 0 0 0 0 0 5 0 0 0 0 0
Q 00 =9 0 Q 60 =1 0 0
C st o
Initial Inventory
Suppose that one of the jacket designs is a model produced last year. Some inventory is left from last year Assume the same demand pattern as before If only old inventory is sold, no setup cost Question: If there are 7000 units remaining, what should SnowTime do? What should they do if there are 10,000 remaining?
Profit
11
12
Profit
11
12
Profit
11
12
P ro d u ctio n Qu an tity
(s, S) Policies
For some starting inventory levels, it is better to not start production If we start, we always produce to the same level Thus, we use an (s,S) policy. If the inventory level is below s, we produce up to S. s is the reorder point, and S is the order-up-to level The difference between the two levels is driven by the fixed costs associated with ordering, transportation, or manufacturing
104 45
$2
$5
$1
$1
$1
Reminder:
10
20
Average =40 30 30
50
60
Inventory Position
Inventory Level
Lead Time
s 0 Time
Notation
AVG = average daily demand STD = standard deviation of daily demand LT = lead time in days h = holding cost of one unit for one day SL = service level (for example, 95%). Also, the Inventory Position at any time is the actual inventory plus items already ordered, but not yet delivered.
Analysis
The reorder point has two components:
To account for average demand during lead time: LT AVG To account for deviations from average (we call this safety stock) z STD LT where z is chosen from statistical tables to ensure that the probability of stockouts during leadtime is 100%SL.
Example
The distributor has historically observed weekly demand of: AVG = 44.6 STD = 32.1 lead time is 2 weeks, desired service level SL = 97% Average demand during lead time is: 44.6 2 = 89.2 Safety Stock is: 1.88 32.1 2 = 85.3 Reorder point is thus 175, or about 3.9 weeks of supply at warehouse and in the pipeline
Model Two:
Fixed Costs*
In addition to previous costs, a fixed cost K is paid every time an order is placed. We have seen that this motivates an (s,S) policy, where reorder point and order quantity are different. The reorder point will be the same as the previous model, in order to meet meet the service requirement: s = LT AVG + z AVG L What about the order up to level?
Model Two:
Risk Pooling
Consider these two systems:
Warehouse One Supplier Warehouse Two LT = 1 week Supplier Warehouse Market Two Market Two Market One Market One
Risk Pooling
For the same service level, which system will require more inventory? Why? For the same total inventory level, which system will have better service? Why? What are the factors that affect these answers?
Centralized A Centralized B
118 226 6 37
Orders 10 11 12 13 14 15
Demands
Centralized Systems*
Supplier
Warehouse
Retailers
Centralized Decision
Memo