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A "lost sales" approach to determining inventory levels at retail locations

Brian Egles www.bjpce.co.uk 07785 527324

The Beer Game


Old sales

Retailer
Orders placed 5 5

Old incoming orders

Wholesaler
Orders placed 5 5

Old incoming orders

Distributor
Orders placed 5 5

Old incoming orders

Old production

Factory
Raw Materials
5b Manufacturing Material Flow

3a Customer sales

3a Incoming orders

3a Incoming orders

3a Incoming orders

5a Production request

Material Flow

Material Flow Incoming Deliveries

Material Flow Outgoing deliveries

Material Flow

Material Flow Incoming Deliveries

Material Flow Outgoing deliveries

Material Flow

6 Material Flow Incoming Deliveries Material Flow Outgoing deliveries 4 2a 3b 1 Packing Material Flow

Inventory
4

Inventory
4 1 2 2 3b 1 2 2 3b

Inventory
4 1 2

Inventory

2b

Orders sold to customers

3b

O incom orders ld ing

Distributor
O rders placed 5

3a Incom orders ing 5

6 M aterial Flow M aterial Flow M aterial Flow

Inventory
O utgoing deliveries 4 Incom Deliveries ing

3b

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

predicts amplification

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: 3

Small retail stores

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: 4

The Supply Chain


Next day Customer Catalogue Sales Customer Off-the-shelf Sales

Factory Imports

5 70 days

Dedicated Warehouse

1 - 3 days

Retail Stores

1 - 3 days
Other Manufacturer Imports

5 70 days

Distributor NDC

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

Bullwhip seen in practice

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

Very intermittent demand


Exampl
5 4 3 2 1 0
Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06

f t r i t rmitt

mand

Demand ( nit )

Dat
Brian Egles Brian.egles@bjpce.co.uk A lost sales approach to inventory November 2010 Slide: #

with no regular pattern


Number f days between demands
5

Frequency

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46

Number f days

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

Starting situation
Erratic demand = variable = bullwhip Store managers setting own inventory Lead times reliable High margin, expectation of convenience Cannot afford to set inventory as days supply Lost sales expensive in and reputation Plans for APO at least 2 years away Need a simple, reliable approach
A lost sales approach to inventory November 2010 Slide: 9

Brian Egles Brian.egles@bjpce.co.uk

Reorder point method

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: 10

Expects normal demand

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

More like POISSON distribution

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

Use to simulate current policies


Store 2590 Lost sales Inventory Max Min

60 Inventory and lost sales (units) 50


Store 2020 Lost sales Inventory

Max Min
Max Min

40 30 20 10 0 Sep Oct Inventory and lost sales (units)

12 10
Store 2882 Lost sales

Max Min
Inventory Max Min

8 Inventory and lost sales (units) 6 4 Dec

12 10 8 Jun Jul Aug BASECASE 50 50 1 Apr May Jun Policy Min Max Rounding Nov Dec Max

Nov

Jan

Feb

Mar

Apr

May

2 Store Average Sales (units/month) 0 Average Lost Sales (units/month) Average Inventory (units)

2590 27.67 0.00 44.01 Sep Oct

Nov

Dec

Policy 6 Min Max 4 RoundingMar Jan Feb 2020 26.67 2.83 4.42 2 0 Sep

Jul

Aug Min

Store Average Sales (units/month) Average Lost Sales (units/month) Average Inventory (units)

Oct

BASECASE 10 10 1 Jan Feb Mar 2882 6.50 0.50 5.08

Apr

May

Jun

Jul

Aug BASECASE 3 10 1

Store Average Sales (units/month) Average Lost Sales (units/month) Average Inventory (units)

Policy Min Max Rounding

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

Conclusion of initial analysis


Store managers inconsistent Can improve reorder point process Likely to be simple as overall process unchanged Need to balance inventory with lost sales Need to be realistic about demand pattern
Highly variable Not normally distributed Standard safety stock methods (VM) do not fit What is a sensible target service level in any case
Brian Egles Brian.egles@bjpce.co.uk A lost sales approach to inventory November 2010 Slide: 14

Estimating the lost profit


For demand = N when target stock level = Q (where N>Q) Lost sales = (N-Q) x Chances of losing the sale Lost profit (L) = Lost sales x Gross Margin% x Material Cost Price

P = Probability of demand N Sum L x P for all N > Q Best explained with an example

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: 15

Lost profit example


Aver e sales per month Working days per month Average sales/day Lead time days Review time days Lead+review time days Cycles/year Holding cost per year Gross margin Chances of losing sale Average sales in lead+review time Material cost price 0.076923 2 3 5 63 20% 100% 100% 0.384615 100.00

Sales Probability 0 0.6807 1 0.2618 2 0.0503 3 0.0065 4 0.0006 5 0.0000 6 0.0000 7 0.0000 8 =POISSON(sales, average, 0.0000 9 0.0000 10 0.0000

0)

If: Target stock (order up to) level = 1 If: Demand = 2, Risked sales = 1 with probability 0.0503 = 0.0503 Demand = 3, Risked sales = 2 with probability 0.0065 = 0.0130 Demand = 4, Risked sales = 3 with probability 0.0006 = 0.0018 ..until probability effectively 0 Total = 0.0653 Estimate of lost profit = 0.0651 x 100% x 100% x 100 x 63 = 409
Brian Egles Brian.egles@bjpce.co.uk A lost sales approach to inventory November 2010 Slide: 16

What will average inventory be?


OUT Order (5) (2)
Average = OUT L T

Average

L (2) T (5)
Note: different if inventory would go below zero but that is not relevant
Brian Egles Brian.egles@bjpce.co.uk A lost sales approach to inventory

L (2) T (5)

November 2010

Slide: 17

Lost profit v inventory tradeoff


Order up to level 0 1 2 3 4 5 6 7 8 9 10 Average stock 0.00 0.73 1.73 2.73 3.73 4.73 5.73 6.73 7.73 8.73 9.73 Risked sales per order 0.38462 0.06533 0.00785 0.00073 0.00005 0.00000 0.00000 0.00000 0.00000 0.00000 0.00000 Lost profit per year 2,407 409 49 5 0 0 0 0 0 0 0 Holding cost per year 14.62 34.62 54.62 74.62 94.62 114.62 134.62 154.62 174.62 194.62 Total cost 2,407 423 84 59 75 95 115 135 155 1.00 175 0.90 195

Minimum

2,500 Annual holding+lost sales cost.

0.80 0.70 Pro a ility 0.60 0.50 0.40 0.30 0.20 0.10 0.00 0 1 2 3 4 5 6 7 8 9 10 Sales in lead+review time (and Order-up-to level) Pro a ility Total Cost

2,000

1,500

1,000

500

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: 18

Effect on examples (1)


Store 2590 Lost sales Inventory Max Min

60 Inventory and lost sales (units) 50 40 30 20 Inventory and lost sales (units) 10 0 Sep Oct Nov Dec Jan 2590 27.67 0.00 44.01 Feb Mar Apr May
Store 2590 Lost sales Inventory Max Min

Max Min

Max Min 2 Jun 0 Jul Aug BASECASE 50 50 1

Store Average Sales (units/month) Average Lost Sales (units/month) Average Inventory (units)

Policy Min Max Rounding 2 0 Sep

Oct

Nov

Dec

Jan 2590 29 0 00 5

Feb

Mar

Apr

May

Jun

Jul

Aug OISSON 5 5

Store Average Sales units ont Average Lost Sales units ont Average Inventory units

olicy Min Max oun ing

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: 19

Effect on examples (2)


Store 2020 Lost sales Inventory Max Min

12 Inventory and lost sales (units) 10 8 6 4 16 Inventory and lost sales (units) 2 0 Sep Oct Nov Dec Jan 2020 26.67 2.83 4.42 Feb Mar Apr May 14 12 Jul 10 Aug BASECASE 10 10 1 Max Min
Store 2020 Lost sales Inventory Max Min

Max Min

Jun

Store Average Sales (units/month) Average Lost Sales (units/month) Average Inventory (units)

Policy 8 Min Max 6 Rounding 4 2 0

Sep

Oct

Nov

Dec

Jan 2020 26.67 0.00 8.42

Feb

Mar

Apr

May

Jun

Jul

Aug OISSON 14 14 1

Store Average Sales (units/ onth) Average Lost Sales (units/ onth) Average Inventory (units)

olicy Min Max ounding

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

Effect on examples (3)


Store 2882 Lost sales Inventory Max Min

12 Inventory and lost sales (units) 10 8 6 4 7 Inventory and lost sales (units) 2 0 Sep Oct Nov Dec Jan 2882 6.50 0.50 5.08 Feb Mar Apr May 6 5 Jul Aug BASECASE 3 10 1
Store 2882 Lost sales Inventory Max Min

Max

Min Max Min

Jun

Store Average Sales (units/month) Average Lost Sales (units/month) Average Inventory (units)

4 Policy Min 3 Max Rounding 2 1 0

Sep

Oct

Nov

Dec

Jan 2882 6.67 0.00 4.58

Feb

Mar

Apr

May

Jun

Jul

Aug OISSON 6 6 1

Store Average Sales (units/ onth) Average Lost Sales (units/ onth) Average Inventory (units)

olicy Min Max ounding

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

Implementation
Extracts from SAP ERP:
Initally MC.9 export and lookups Business Objects report once proven

Calculation in Excel using simple macros


MinCostStockTarget(DL, DR, , C, H%, NR, M%, L%, Tmax, F, Smin) Use product hierarchy to set L%

Upload back into SAP ERP:


Initially cut & paste into Mass Maintenance Visual basic to write batch input / WinShuttle
Brian Egles Brian.egles@bjpce.co.uk A lost sales approach to inventory November 2010 Slide: 22

Result
Inventory changed very little
Small reduction Masked by growing business and new products

On shelf availability improved Estimated revenue >250k / year Time saving in stores improves service reliability Central team credibility prior to APO project

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: 23

Simulation to validate method


Generate probabilistic demands

Supply Simulate replenishment

Warehouse

Retail

Simulate replenishment

Set key decision variables


(e.g safety stock)

Calculate total inventory

Determine lost sales

Establish overall cost objective

Brian Egles Brian.egles@bjpce.co.uk

A lost sales approach to inventory

November 2010

Slide: #

Thankyou
Brian Egles www.bjpce.co.uk 07785 527324
http://bjpce.co.uk/index.php/contactlist/thesisrequestmenu

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