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Inventory is one of the dominant costs. Effective inventory management in the supply chain
is to have the correct inventory at the right place at the right time to minimize system costs
while satisfying customer service requirements.
to find the optimal order policy that minimizes annual purchasing and carrying costs while
meeting all demand.
We refer to the time between two successive replenishments as a cycle time. Thus, total
inventory cost in a cycle of length T is
+
2
since the fixed costs is charged once per order and holding cost can be viewed as the
product of the per unit, per time holding cost, h; the average inventory level, Q/2 and the
length of the cycle, T
total cost per unit of time
2 KD
Q*
h
It is more difficult to match supply and demand, and the second one implies that it is even
more difficult if one needs to predict customer demand for a long period of time..
The third principle suggest for instance, that while it is difficult to predict customer demand
for individual SKUs, it is much easier to predict demand across all SKUs, within one product
family
ADDITIONAL INFORMATION
Fixed production cost: $100,000
Variable production cost per unit: $80
During the summer season, selling price: $125 per unit
Salvage value: any swimsuit not sold during the summer season is sold to a discount store
for $20
TWO SCENARIOS
Manufacturer produces 10,000 units while demand ends at 12,000 swimsuits
Profit
= 125(10,000) - 80(10,000) - 100,000
= $350,000
Marginal profit/unit =
Selling Price - Variable Ordering (or, Production) Cost
Marginal cost/unit =
Variable Ordering (or, Production) Cost - Salvage Value
If Marginal Profit > Marginal Cost => Optimal Quantity > Average Demand
If Marginal Profit < Marginal Cost => Optimal Quantity < Average Demand
(Q,R) policy whenever inventory level falls to a reorder level R, place an order for Q units
What is the value of R?
Q
Average inventory = 2
z STD L
STD
RISK POOLING
Risk Pooling suggests that demand variability is reduced if one aggregates demand across
locations. This reduction in variability allows a decrease in safety stock and therefore
reduces average inventory. Essential to understand the concepts of standard deviation and
coefficient of variation of demand. Standard deviation is a measure of how much demand
tends to vary around the average, and coefficient of variation is the ratio of standard
deviation to average demand:
=
standard deviation measures the absolute variability of customer demands, the coefficient
of variation measures variability relative to average demand.
1) Centralizing inventory reduces both safety stock and average inventory in the system
2) The higher the coefficient of variation, the greater the benefit obtained from
centralized systems; that is, the greater the benefit from risk pooling
3) The benefits from pooling depend on the behavior of demand from one market
relative to demand from another.
Service level when the centralized and decentralized systems have the same total safety
stock, the service level provided by the centralized system is higher
Overhead costs typically these costs are much greater in a decentralized system
Customer lead time. Since the warehouses are much closer to the customers in a
decentralized system, response time is much shorter
Transportation costs. The impact on transportation costs depends on the specifics of the
situation
FORECASTING
1 Forecast is always wrong
2 The longer the forecast horizon, the worse the forecast
3 Aggregate forecasts are more accurate
Forecasting is a critical tool. Forecasts arent just for inventory decision making; decisions
about whether to enter a particular market at all, about whether to expand production
capacity, or about whether to implement a given promotional plan can all benefit from
effective forecasting
- Qualitative primarily subjective, rely on judgement (JUDGEMENT METHODS)
- Time series use historical demand only, best with stable demand
- Causal relationship between demand and some other factor
- Simulation imitate consumer choices that give rise to demand
Time series methods use a variety of past data to estimate future data,
Common time series methods
Moving average each forecast is the average of some number of previous demand points.
Select the number of points in the moving average so that the effect of irregularities in the
data is minimized
Exponential smoothing each forecast is a weighted average of the previous forecast and
the last demand point. This method is similar to the moving average, except that it is a
weighted average of all past data points.
Methods for data with trends the previous two approaches assume that there is no trend
in the data. If there is a trend, methods such as regression analysis and holts method are
more useful, as they specifically account for trends in the data. Regression analysis fits a
straight line to data points, while holts method combines the concept of exponential
smoothing with the ability to follow a linear trend in the data.
Methods for seasonal data a variety of techniques account for seasonal changes in
demand. For example, Seasonal decomposition methods remove the seasonal patterns
from the data and then apply the approaches listed above on these edited data. Similarly
winters method is a version of exponential smoothing that accounts for trends and
seasonality.
JUDGEMENT METHODS
Judgment methods strive to assemble the opinions of a variety of experts in a systematic
way.
Panels of experts can be assembled in order to reach a consensus. This approach assumes
that by communicating and openly sharing information. A superior forecast can be agreed
upon. These experts can be external experts or internal experts.
The Delphi method is a structured technique for reaching a consensus with a panel of
experts without gathering them in a single location. Indeed, the technique is designed to
eliminate the danger of one or a few strong willed individuals dominating the decision-
making process. Each member of the group of experts is surveyed for his or her opnion,
typically in writing. The opinions are compiled and summarized and each individual is given
the opportunity to change his or her opinion after seeing the summary. This process is
repeated until a consensus is achieved