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Module 2
Managing Material flow
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Inventory Management5
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Content.
Introduction Type of inventory
Inventory related costs
Managing cycle stock
Managing saftey stock
Managing seasonal stock
Analysing impact of supply chain redesign on the
inventory
Managing inventory for short life cycle products
Multiple item, multiple location inventory
management
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0
1
2
3
4
5
6
7
8
9
10
chemical textile machiner y non metallic mineral transport metal and metal
products
food and beverages
years
in
ve
n
to
ry
tu
rn
ov
e
r
ratio
1991 1996 2001 2006
Sector-wise Inventory
Performance
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Sector-wise Performance on
Inventory Turnover Ratio in India
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Types of Inventory
Cycle Stock : Economies of scale
Safety Stock
Anticipation Stock
Seasonal Stock
Speculative Stock
Pipeline Inventory
Dead stock
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Drivers of Inventory
Type of Inventory Driver ( Logic)
Cycle Stock Economies of Scale
Safety Stock Uncertainty in demand & Supply
Seasonal stock Mismatch between demand and supply rate
Speculation Stock Uncertainty in price of material
Pipeline Stock Lead-time in production/transportation process
Dead Stock Judgmental error/ Change in economic or technological environment
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Inventory Management: Key
Decisions
How much to order?
When to order?
Where to hold inventory? When to review?
Continuous review systems ( Fixed order
quantity) Periodic review systems
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Inventory in Chain
Supply chain consists of series of stock points
connected byprocesses ( conversion processes and
transportation processes) Each stock point has demand process and supply
process
Inventory at stock point : cycle stock, safety stock,
seasonal stock
Inventory within conversion and transportation
processes:
pipeline inventory
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Pipeline Inventory
Inventory within conversion andtransportation processes:
Pipeline Inventory Pipeline Inventory = PLT * D
- PLT = Pipeline Lead-time; D = averagedemand
Illustration :
LT -Shipment by air = 7 days
LT- Shipment by sea = 45 days
Average demand = 100/day
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Inventory Management: Relevant
Cost
Ordering cost/setup cost
Inventory carrying cost
Cost of shortage Lost sales
Backlogging cost
Service level as proxy for cost of shortage
Purchase cost ( value addition cost) of
Item
Not relevant if cost of item is not function of
order quantity (No Quantity discount case)
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Cycle-stock Inventory
Fixed Order Quality Model ( Cont. Review Model)
Q=Order Quantity, Reorderpoint= L*d
Average cycle stock = Q/2
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Optimal Order Quantity Trade-offs
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Inventory Models: Cycle Stock
__________
Q = 2 AD/ i C
A = Ordering Cost /Cost of setup
D = Annual Demand
i = Inventory carry costC = cost of item
Q= Optimum order quantity
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Optimum Order Quantity
DailyDemand =100
Working days in year=300
Ordering cost = 256 Rs.
Cost of item = 30 Rs.
Inventory-carrying cost = 0.2 Rs./Rs./Year
Supplier LT = 15Days
Optimum order Qty. =
_______________________
(2*256*100*300/(30*0.20 ) = 1600
Average cycle stock= 0.5* 1600 = 800
units
Reorderpoint= 15*100 =1500
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Total Cost versus Q
0
5000
10000
15000
0 1000 2000 3000 4000
Q
TotalCo
st
Series1
Optimum order quantity=Q*= 1600
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Q/Q* Q Tc0.5 800 12000
0.75 1200 10000
0.9 1440 9653.333
1 1600 9600
1.1 1760 9643.636
1.25 2000 9840
1.5 2400 104001.75 2800 11142.86
2 3200 12000
Sensitivity Analysis
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Safety Stock
R= reorderpoint
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Safety Stock
Distribution ofDemand During Lead Tim
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Ordering Policy in Case of
Demand and Supply Uncertainty
Order quantity = Q* = Optimum order
quantity
Reorderpoint= D * L + K WLead Time Demand
K = Safety factor
Safety stock= K WLead Time Demand
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Impact of Safety Factor on
Service Level
Safety factor (K) Service level
0 0.500
0.5 0.690
1.0 0.841
1.5 0.933
2.0 0.977
2.5 0.9943.0 0.998
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Impact of Service Level On Safety Stoc
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Safety Stock: Demand Uncertainty
Only
S.S = K WLead Time Demand
______
WLead Time Demand = LWD2
D = average Demand ,WD = S.D. ofDemand ,
L = Lead-time, K = Safety Factor
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Safety Stock : Demand and
Supply Uncertainty
S.S = K WLead Time Demand
____________
WLead Time Demand = LWD2 + D2 WL2
D = average Demand ,WD = S.D. ofDemand ,
L = Average Lead-time, WL = S.D. ofLead-time
K = Safety Factor
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Inventory Profile at Stock Point:
Cycle Stock + Safety Stock
Inventory
Time
Average
Inventory
Cycle Inventory
SafetyInventory
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Basic Demand and Lead-time Data
Demand Data
d1 d2 d3 d4 d5 d6 d7 d 8 d 9 d10Demand 115 95 150 125 28 90 93 115 93 96
Lead-time data
L1 L2 L3 L4 L5 L6 L7 L 8 L 9 L10
Lead-
time
12 15 4 21 18 11 12 18 19 20
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Inventory Management
Cycle and Safety Stock
DailyDemand: Mean = 100 , SD = 30
Ordering cost = 256 Rs.
Cost of item = 30 Rs.
Inventory-carrying cost = 0.2 Rs./Rs./Year
SupplierPerformanceMean = 15Days , SD = 5
Service Level = 98%
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Average
Demand
Standard
deviation
of demand
Average
lead-
time
Standard
deviation
of lead-
time
Safety
stock
- units
Safety
stock in
days of
inventory
Remark
100 30 15 5 1026 10.3 Base case
100 30 15 0 232 2.3 No supplyuncertainty,
100 0 15 5 1000 10 No demand
uncertainty
100 15 15 5 1006 10 Reduce demand
uncertainty
100 30 15 2.5 526 5.3 Reduce supply
uncertainty100 30 7.5 5 1003 10 Reduction in
lead-time
Impact ofChange in Demand and
Supply Parameters
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Managing Seasonal Stock
Capacity versus inventory tradeoff in
seasonal demand//supply situation
Two basic approaches in aggregate
planning ( Sales and operations
Planning)
Chase Option : Produce as per demand Level Option:
Mix apparoches
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Q1 Q2 Q3 Q4
Demand 8000 8000 8000 12000
Level option
Production 9000 9000 9000 9000
Hiring Cost 0 0 0 0
Inv. C. Cst 3000 6000 9000 0
Chase option
Production 8000 8000 8000 12000
Hiring Cost 0 0 0 48000
Inv. C. Cst 0 0 0 0
Illustration: Managing Seasonal
Stock
Cost: level option= 18,000 Chase option= 48000
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Centralized Versus Decentralized
Systems
Inventory
Safety Stock
Cycle stock Service Level
Overhead Costs
CustomerLead Time Transportation Cost
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Centralized Versus Decentralized
Systems: Illustration
Demand distribution at each region ( 16 regions)
DailyDemand: Mean = 100 , SD = 30
Ordering cost = 256 Rs.Cost of item = 30 Rs.
InventoryCarrying cost = 0.2 Rs./Rs./Year
Plant Lead time:= 15Days ( No supply Uncertainty)
Transportation:
Decentralized- Rs. 1per unit
Centralized case: - 10% higher
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Decentralise
d system 16stock points
Centralised
system 1stock point
Cycle
stock/stock
point = Q*/2
800 3200
Safety Stockper stock
point
232 928
Total Inv. in
units for the
system
(232+800) v16
= 16512
928+3200
= 4128
Total Inv.carrying cost
16512 v 6= 99072
4128 v 6= 24768
Incremental
Transportatio
n cost
300v100v16v0.1=48,000
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Centralization
Physical centralization
Decentralized inventory & centralization
of information
Specialization at each stock point
Mix ofCentralization & decentralization
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Impact of Inventory Pooling
Centralization of inventory
Product substitution
Component commonality
Postponement
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Inventory for Short life-cycle
Products: Single Period Model
Balancing cost of under-stocking versus cost of
overstocking
CU = Cost of under-stockingCO= Cost of overstocking
Optimum service level = (CU *100/ (CU + CO)
Optimum Order size= Mean demand
+ K * Std. Dev. Demand
K= optimum service level
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Optimum Order for a New Music
CD
CDpurchase price = Rs. 200
CD sales price = Rs. 300
CD sales price after first weeks = Rs. 62.Demand: Average 100 and Standard Deviation 30
- What is optimum order quantity
- If manufacturer offers buyback scheme , would your
decision change?- Cost of administering return- Rs. 53
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Selective Inventory Control
techniques
ABC classification
FSN Classification
VEDClassification
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Class Percentage of items Percentage of Total
sales Value
A 5-15 55-75
B 20-30 20-30
C 55-75 5-15
ABCClassification
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ABCClassification: Kurlon
Case
40
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Improving Inventory TurnsType of Inventory Driver ( Logic) Improvement focus
Cycle Stock Economies of Scale Reduce ordering/setup cost
Safety Stock Uncertainty in demand & Supply Reduce demand & supply
uncertainty & Reduce LT, supply
chain redeisgn
Seasonal stock Mismatch between demand and supply
rate
Reduce Seasonality in demand,
Create flexible capacity
Speculation Stock Uncertainty in price of material Risk management
Pipeline Stock Lead-time in production/transportation
process
Reduce Lead Time
Dead Stock Judgmental error/ Change in economic
or technological environment
Anticipate changes in demand
structure
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Summary
Indian firms find that a significant amount ofmoney is locked up in the inventory.
Organizations should use the concept of
zero-based inventoryplanning to improvetheirperformance on the inventory front.
The decision maker controls inventory by
deciding two critical questions: How much to
order and When to order
Based on the demand characteristics, supply
characteristics, cost structure and desired
service level firm can decide optimum level
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Backup Slides
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INVENTORY TURNOVER RATIO for
MANUFACTURING INDUSTRY
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
199
0
199
1
199
2
199
3
199
4
199
5
199
6
1997
199
8
199
9
2000
2001
2002
2003
2004
2005
2006
YEAR
inventory
tu
rnoverratio
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Inventory Turns in US economy
Year Manufacturer Wholesaler Retailer
20018.57 8.89 7.95
19917.50 8.89 8.28
http://www.bea.gov/national/nipaweb/NIPA_Underlying/SelectTable.asp?Benchmar
k=P#S0
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Inventory Turnover performance
in US Retail *
Study looked at 311publicly listed retailers foryears1987-2000
Overall trend in inventory turns is downward slopping
during 1987-2000
time trend is negative for176 firms
time trend is positive for135 firms
* Guar, Fisher & Ananth Raman- Management Science.February,2005 51(2) 181-194
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EOQ Model: Quantity Discount
Case
Minimize Total Cost : Annual purchase cost ( D *c) +
Annual ordering cost+ Annual Inv. Carrying cost
- Calculate optimal Q* for each price category- Determine optimal feasible Q for each price category
- Compare total cost across all the price categories
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