.

ESTIMATING AND AUDITING AGGREGATE INVENTORY LEVELS

AT MULTIPLE STOCKING POINTS

Technical Memorandum No. 478

by

Ronald H. Ballou

Case Western Reserve University

May, 1980
 Abstract

Relatively little attention has been given to methods for

estimating and auditing distribution network inventories in the

aggregate. This article shows a polynomial equation of the form

N
IT = I(w+mDi+aD ) which has theoretical verification is a good,
basic tool for estimating overall inventory levels as well as pro-

viding insight into the effectiveness of inventory control policies

at different stocking points. It also serves as a method for audit-

ing and controlling current inventory policies on an on-going basis.

Testing the model in a number of cases where "pull" distribution
strategies were in effect revealed that good inventory policy could

be represented by IT = KID whdie b ranges between 0.65 and 0.75.

"

ESTIMATING AND AUDITING AGGREGATE INVENTORY LEVELS

AT MULTIPLE STOCKING POINTS *

When multiple product inventories are to be positioned in a

distribution channel, it is necessary to estimate how much stock

will be held at each stocking point. This estimate is critical

to the determination of system-wide inventory costs as well as bal-

ancing these costs against other conflicting costs such as produc-

tion, transportation, and order processing to determine the optimal

number, location, and size of the stocking points. This paper de-

scribes a polynomial model that has proven useful in planning,

analysis, and auditing of the inventory component of logistics sys-
tems, as well as in appraising the performance of in-place inventory
stocking policies on a company-wide basis. It illustrates the in-

sights to be gained from a "top down" or aggregate representation

of a firm's execution of its inventory policy which serves as a basis
for estimating the impact of inventory policy change as as well as
monitoring the effect of that change on distribution network costs.

It also shows the range of the relationship experienced in practice

that serves as a guide for auditing as well as estimating inventory

levels when little or no data are available.

Nature of Inventory Consolidation Effects

Estimating aggregate inventory levels for products held at

multiple sites is complicated by the fact that the amount of stock

needed to support a particular level of demand and a given service

*The author wishes to acknowledge the assistance of Mr. Hal Blain,

Senior Vice-President, Drake Sheahan/Stewart Dougall, Inc.,
in the preparation of this article.

-1-
li

-2-
level is usually not proportional to the number of stocking

points. For example, if sales are routed through 1/2 the number
of existing stocking points, the total inventory required may
drop by 1/3 of its previous level. This disproportionality is

effect." This ef-

referred to as the "inventory consolidation
fect alone encourages management to seek the smallest number of

stocking points possible. A countervailing economic force to the

inventory cost in transportation cost, where the relatively lower

inbound rates to a stocking point, as compared to outbound rates,
encourages the selection of a large number of stocking points

demand. The decision concerning

close to major
the number concentrations
of stocking points of
and how much inventory should be

placed at each location is a result of optimally balancing these

conflicting costs.
Determining transportation costs is relatively simple and

accurate since rates are published for common carriers or, in the
case of private carriage, they can be determined through straight-
forward accounting practice. The inventory consolidation effects

less accurately determined _because they are a result of

- __ - _established
are _much inventory replenishment rules, and the execution of
these rules is highly individualized by company and by stockkeeping

persons. Therefore, inventory levels and costs must be determined

on a company-to-company basis. A simple method for estimating

overall
purposesinventory
since it levels would
replaces the be usefulive
alternat foritem-by-
planning and
item auditing
estimati ng

procedures that are impractical when there are hundreds of stock-

keeping items held at many stocking points.

 -3-
A Simple Relationship

Inventory level by stocking point and for the distribution

system as a whole is a result of the execution of a stocking policy.

Surveys have shown that over 90 per cent of the U. S. firms now use
computerized procedures for controlling inventory s€ocking levels,
1
especially for finished goods. ·Where demand is reasonably random,
as is usually the case when it is generated from a large number of

customers acting independently of each other, and no customer orders

apply. Most com-
dominate, statistical inventory control procedures
puter models such as the popular IBM IMPACT system are based on them.
With these procedures, it is possible to determine system-wide in-
ventory levels through an item-by-item analysis. However, such an

approach when there may be thousands of stock items located in many

stocking points becomes impractical to execute. As an alternative,
an estimating equation that is a derivative of the basic theory can

be developed. As shown in the appendix, such a relationship has

the following general form.
1
I = N
T (w+--1--
mD.+aD1
b) (1)--
-T-----6
i=l

where:

IT = System-wide inventory, units or $.

Di = Total warehouse throughput, units or $.

N = Number of stocking points in which the products are stored.

w,m, a,b = Constants to be determined from company data usually
by curve fitting procedures.
The terms in the equation have the following general meaning:
:
-4-
w represents the average amount of promotional, speculative, ob-

solete, or production overrun stock in a stocking point,

mD.
1 is the amount of safety stodk in the ith stocking point, and
I
aD is the amount of regular stock in the ith stocking point.

Although any number of stock control policies may be encountered

in practice, the model is sufficiently robust to accurately rep-

resent a wide variety of inventory policies yet, by combining terms,

it can be made quite simple with only a minor loss of accuracy.

Nb N
In fact, reducing the model to a form such as IT = IaDi or IT =.I(w+mDi)
i=l 1=1
has proved particularly useful in practice since the broad model

form becomes a little trickier to curve fit and all terms usually
are not statistically significant. Consider the nature of one of

these reduced forms.

Theoretically, when inventory control is based on statistical
' inventory theory, the total inventory throughout a system of multiple

warehouses can be determined from the following expression.

D.S r- o LT
|

1 + Z.S 1

IT =i-1 2KC 1. -1»31_« (2)

Regular Safety -
stock stock
where:

I
Di = demand throughput at warehouse i
sD = standard deviation of demand

K = carrying cost in percent

C = average product value

S = order processing cost

Z = number of standard deviations for a given service level

"
I
5-

N0 = initial number of stocking points

N = revised number of warehouses

LT = average replenishment lead time

IT = total system inventory

Therefore, the system inventory level is sensitive to the

number of stocking points in the system and the demand throughput

at each stocking point. More simply, Equation 2 reduces to the form:

IT -i=]N
a 1.
Thus, theoretically, we would expect total inventory to be a

function of the number of stocking points or the throughput levels

at the stocking points, and be related to them in a square root

fashion. For a number of.reasons, we will find that this does not

strictly hold in practice.

Observing the Model in Practice

The benefit that the simple model has is that it can be struc-
tured from existing data that are readily available within most firms.

Inventory level information is typically maintained on a periodic

basis, usually monthly, for -each stocking point. The data may be
--
aggregated as a total dollar value or on a product-by-product basis
reports. Which data to use depends on how
as given in stock status
different product groups vary as to the way in which order quantities
are determined and the service level set on each, and on the level

of estimating accuracy expected from the model. An example of the

use of aggregated data is shown in Figures 1 through 3. Individual

item data appear later in Figure 4, but of course with somewhat

li
l
-6-
increased variability compared with the aggregated data.

Figure 1 shows the average inventory level for all products

as a function of the total annual throughput for 23 warehouses

out of approximately 100 in operation by a firm that produced
and distributed industrial cleaning compounds for industrial and
institutional use. If a power function is fitted to the data,

the estimated average inventory level (Ii) in a warehouse having

0 635
'

a throughput of Di is given by Ii = 2.986 D.1 The system

inventory is an.extension of this formula and is given by

N N 0.635
IT =I Ii = 2.986 i=1
I Di (3)
1=1

This line fits the data with a coefficient of determination of

R 2 = 0.82.
Looking at the data in Figure 1, one might ask why a linear

representation of the data (the second simplified model that was

previously suggested) might not offer Nreasonable accuracy. A

linear-relationship of the form IT = I (w+mDi) fits the data with
i-1 .
a coefficient of determination of R2 = 0.85, about the same as the
functionT Ho-weve-r, if we-believe -the - concave nature of the-
power
inventory function to be correct due to statistical inventory theory

based inventory policies and a predominance of cycle stocks, as

was the case in this company, reducing 23 warehouses down to 1 will

result in at least a 250 percent overstatement of the network in-

ventory levels with the use of the linear expression.

A second example involves a manufacturer of water treatment
chemicals. In this case there were 10 stocking points at both plants
 ... . 1./ ..

500 -

1.)

400 -
Warehouse v) 4-
average
inventory
level,
000's lb.
300 -

200 - -
1

(i,
0
-5
_.-Ii »/-« 1 /8
I - . 6 Di.0.635
2
R = 0.8 2
-
1

«»
(:)
6.15)

0 ic/'4
-) I ':)4 C.' O

100 »« .
0 1 0
1

1 1 . 1 . 101 1
0 1 1
0 200 400 600 800 1000 1200 1400 1600

Annual warehouse throughput, 000 's lb.

1

Figure i. Inventory consolidation curve for a prcubcer of industrial. cleaning compounds.

 8-

and warehouses. The plot of the data is shown in Figure 2. The

computed curve was

I. = 44.4 D. ' 632
0 (4)
1 1

with a coefficient of determination of R2 = 0.48, which was not

particularly good. This was due mainly to inconsistent inventory

policies at several plant stocking points.

A third example, as shown in Figure 3, is for a producer and

distributor of dry grocery products. In this case the curvilinear

relationship of
0.68
I. = 0.311 D.
1 1 (5)
2
offered the best fit with an R = 0.83. The constant term was near-

ly zero and has been eliminated from the relationship. However , the

straightline relationship of

I. = 0.596+0.091 D. (6)
1 1

with an R2 = 0.76 was selected. The reason was that the constant
term in the equation better represented the high level of promotional

merchandise and production overrun stocks typical in these food fin-

-
ished goods- inventories--than did the curvilinear-relationship. - - -
Another example involved a steel products distributor operating
8 warehouses. Forty-two (42) products were sampled within a common
product group from the company's stock status report. The results

are shown in Figure 4. The curve in this case was

0 90'

I, = 7,10 D. (7)
J J

where D represents the demand for a particular item within a product

i group. The R = 0.64 and total inventory is the sum across all items
in all warehouses.
 -9-

-Dallas
400 -
0 plant
0- Phoenix
plant

300 -
Warehouse 1

average L_ 0.632
inventory, I. = 4.44 D.
11
000's lb.
2
200 - * R = 0.4 8
e
m0
100 -

0 0 Minneapolis
plant
0 1 .J 1
0 500 1000 1500
-- - ---.- .--.------- .Annual warehouse throughput,_ _SOO's__lb.

Figure 2. Inventory-demand data for a water treatment chemical

producer.

1
 .. .. ..

I. = 0.59641 + 0.09055 D-
1
0.68
R2 = 0.76 0 0 Ii = 0.311579 D.1
R2 = 0.83

3 -.

m
Average
inventory
level »,
0
00,000'S)
2-
0 m .0
0 0 0
GA
.J
. .

El iIi]

0 0 1977 Data
0 21 1978 Data
1
-
E]

0 0 10 20
1 301 1 1 3 401 1 1 1
50

Annual Throughput ($000,000's)

Figure 3 . Two inver tory-throughput relationships for a producer and distributor
of dry grocery products.
 - 11 -

100

W 75
ehouse
average e
nlntory,
0*'s lb.
@

50 e
e
e

25 ® 0 90
Ii = 7.1 Di '
1 ee 0 2
e
o R = 0.64
%
01/0 9e
0o .e 0
/8 -lio. e
O .-#*- 1 * 1 1
- -0--- ---- -- ----. - 5--- - -- --- ..__ 10__ __ __ 15

Monthly item warehouse throughput, 000's lb.

Figure 4. By-item inventory-demand data for a steel products

distributor.

li

.4
..
- 12 -

Other similar analyses which are summarized in Table 1

have shown the exponent on demand for the curvilinear relation-

ship usually to range between 0.65 and 0.75 with a mean of about
0.7. Thus, depending on the nature of the inventory policy used,

we now have a guideline with which to evaluate a given company's

inventory control against its stated policy. That is, departures

of the fitted model compared with what the stated policy would
dictate requires careful consideration. Also why the exponent
on demand is not as low as the 0.5 that theory suggests is possible

requires further discussion.

0.5
Departures from D.1

The reasons for the exponent on demand being greater than the

0.5 as would theoretically be expected when cycle stocks are

dominant in the inventory are important to note as the model pro-

vides insights into the operation of the inventory control system.

Since observed exponents are generally greater than 0.5, somewhat
more inventory is being held after consolidation of stocking points
than would be anticipated based on theory alone. There are several

practical reasons for the exponent to be greater than 0.5.

1. A number of the items in the product group may be joint
ordered causing increased inventory levels so as to
realize the benefits of volume buying or shipping.

2. Forward buying, or promotional stocking, or dead stocking

or over production to current requirements may be occurring
in anticipation of future market needs.

3. Some modified control policy different from an optimal

"pull" policy for single items may be in effect.

4. A "push" distribution system strategy may be used where

production considerations override replenishment stocking
policies.
 - 13 -
1
TABLE 1

Selected examples of aggregate inventory

relationships and range of exponent "b"
for a variety of companies

Product Estimated Inventory pojicy Fit to Exponent

a 2
description relationship description data,R "b"

Over the Stock to 6 -

counter weeks
drugs demand 0.99 1
IT=I(0.53+0.11Di)
Vacuum r 0.60 Mixed push-
cleaners pull strategy NA 0.60
IT=45.61D.1
Dry Order quantities
groceries set to 1 week
IT=I(12.8+0.09Di)
forecast plus a
fixed safety
stock. 0.96 1

Replacement Varies by stocking High, but

parts for point and by in- only 4
large equip- ventory controller points in
ment I =5.5 ID.0.84 data base 0.84
T 1
Outboard MIN-MAX control
boat b 0.68 with some pushing
motors I =21TD. of production
T 6 1
overruns into field
warehousing 0.50 0.68

Outboard MIN-MAX control with

b
boat motors
IT=I(85,230+0.3Di) substantial volume
buying pushed into
field warehousing__ 0.95 1

Marine parts Pull strategy with

0.74
& accessories I T=20TD. MIN-MAX control 0.91 0.74
L l
Medical r 0.91 Predominantly push
gloves I
T=0-61D.1 strategy due to
large production
runs. 0.64 0.91

Medical Pull strategy based

needles & r 0.67 on weeks of demand
syringes I
T=16.91D.
1 with some push
overrides. 0.88 0.67
 - 14 -

Product Estimated a Inventory P81icy Fit to Exponent

description relationship description data,R2 "b"

Small appliance r 0.57

service parts NA NA 0.57
IT=37.8LD i

Shoes I =0 5TD. Stock to demand Fit to

T -Ll 1
policy
Recreational
goods I Stock to demand Fit to
T =0.1ID.1
policy 1

Replacement r. 0.60
parts I =26.910.
i Mixed push-pull
T strategy NA 0.60
.. 0.78 NA 0.78
Candy I Unknown
T =98.91D.
products 10.65 NA 0.65
Unknown
IT=67.7ID.1

Drugs & . 0.62

sundries I =0 710. Pull strategy based 0.96 0.62
T'l
on IBM's IMPACT
program.

a
A relationship expressing the execution of the firm's inventory policy.
b
Competing divisions of same parent company except second division
makes substantial buys from foreign manufacturers.
C Statement of the firm's actual inventory policy.

Source: Various
facilitydistribution planning studies involving the DISPLAN
location model.
 - 15 -

5. There may be multiple product types with different

service policies represented within the aggregated
product group.

6. There may be departures from the assumptions on which

the theory is based.

7. An inventory policy may be followed that relates

inventory levels directly to demand.
N b
Uses of the I T =T (w+mD.+ aD.)Model
11
itl

There are two primary uses that the model has in the strategic

planning of distribution systems. First, it permits the current

inventory policies to be audited. Second, it provides a method by

which overall inventory levels may be estimated for a varying number

of stocking points.
As an Audit Tool

A common question raised by management during an audit of

operations is whether inventory levels are being controlled as ef-

fectively as they might be. Although item sampling could be con-
ducted and relevant cost data collected to estimate inventory levels

by means of economic order quantity formulations, this is expensive

and time consuming when only initial impressions are desired. Thus,

the power function model can- provide the necessary insights that

can lead to more in-depth analysis, if appropriate.

First, the model provides information about the nature of the

control process. The value of the exponent on demand of the power
term in the model is the key. If cycle stocks are scientifically

managed, we would expect the exponent to approach 0.5. However,

as the exponent approaches 1.0, inventory stocking rules that tie

inventory levels directly to the demand level would be expected.

 - 16 -

For example, Figure 1 shows the nature of the model to be expected

from a reasonably managed inventory with little promotional stock

or no excessive safety stock. Approximately 750 product line items

located in about 100 public warehouses were controlled by means of

a computerized MIN-MAX inventory program. Even though product items

were aggregated into one group, the exponent is respectably close

to 0.5 and the R2 = 0.82 is reasonably high.

Contrast this with the situation in Figure 4. The exponent

of 0.90 departs significantly from 0.5. The level of the exponent

should raise questions about the nature of the inventory control

policy. In fact, the policy was one of maintaining inventories at

a level equal to four-months' demand. Since the exponent is close
to 1.0, the model is reflecting the linear nature of this policy.

Second, the scatter of the data about the estimating line

provides important insights as to the effectiveness of the firm's

inventory control policies. Again, the companies represented in

Figures 1 and 3 can serve as benchmarks. We should expect some-

thing less than a perfect fit of the model to the data due to

normal variability in the execution of inventory policies. However,

the case does show the level of the accuracy that can be achieved.

A sharp contrast is seen between the fit of the line in Figure 2

compared with Figures 1 and 3. Only 48 percent of the variation

in the inventory level in Figure 2 is explained by the model. This

is not particularly impressive. When management was asked about

those stocking points that departed significantly from the line,

the response was that the points represented inventories maintained

 - 17 -

at the plant sites. In those cases, the plant managers controlled

their own inventory levels. Differences in philosophies about pro-

ducing to order or producing to inventory explained the high varia-

bility. The company is in the process of centralizing and comput-

erizing the inventory control throughout its production-distribution

system. The potential inventory reduction, if the variability in

inventory control practice between stocking points can be eliminated,

is estimated to be 17 percent of the current average inventory level.

As an Estimating Tool
The use of the model as a tool for estimating the overall in-

ventory level is important to strategic planning. Because of the

substantial investment often required of inventories and annual

carrying costs typically ranging from 20 to 40 percent of the in-

3
ventory value , top management must continually be concerned with
how inventory investment levels change with alterations in the dis-
tribution network design.
Once the model has been established for the existing inventory

policy and number of stocking points, it is a relatively straight-

forward_ mat-ter_to _estimate inventory levels at individual stocking

points or for the entire network. It is necessary to forecast or

otherwise determine the throughput at each stocking point. The

substitution of the appropriate Di value for each stocking point i

into the formula gives the estimated inventory level at that point.

Accounting for all demand in this manner gives the overall inventory
level. The number of stocking points and, therefore, the demand on

each point may be changed and the inventory levels estimated again
in this manner to accomplish a sensitivity analysis.
 - 18 - -

The usefulness of the model does not end here. In addition,

management often wishes to know the minimum inventory levels that

could be achieved under a well-managed control system. After

adjusting the exponent downward to the theoretically lower bound

value of 0.5, assuming the power fundtion reduced form of the

polynomial model to make an estimate of the inventory levels at all

stocking points, it is necessary to approximate the constant in

N
the formula, i.e., the "a" value in IT = aID."5 for each item
i=11
sampled. A number of "a" values will be found which are then averaged.

To illustrate, consider a sampling of the points presented in

Figure 4 since they are for a number of items. First, we know that

S = $5/order, K = 20 percent, N = 8, N = 8, LT = 1.0 month, and

Z = 1.65 for normally distributed demand at all stocking points with
a 95 percent service level. There is an insignificant amount of

promotional stocking or over buying. Next, the inventory level for

the item is determined theoretically when a given number of stocking

points is assumed. Table 2 shows the calculations. The estimating

formula for the theoretically optimum policy would be IT =12.BIDio.5.
1=1
Thus, for an item or group of items having a monthly demand of 1000
lb. in each of 5 warehouses, the total inventory would be 2023 lb.

According to the formula in Figure 4, the firm is estimated to be

now stocking 17,800 lb. of steel products in this particular prod-
uct group.
As a Control Tool

In addition, the model can be used as an evaluation tool on a

continuing basis to monitor inventory control performance. Actual
" or idealized aggregate inventory relationships may be established to
 - 19 -

TABLE 2

Approximating the Constant in the Inventory

Level Estimating Formula

(3)=(2)4(1)
(1) (2)
05
C. S D. D... I.
Product i d 1 1 1 a
§ 1 .10 25 2312a 48.08 578.83
b
12.0

2 .12 186 16586 128.79 1621.32 12.6

3 . 09 13 1192 34.52 428.34 12.4

4 .08 44 2271 47.66 668.28 14.0

5 .10 111 12435 111.51 1429.90 12.8

Simple average a=12.8

aMonthly demand

\1 (2312) (5) 1
b + 1.65(25)\ (8/8)1 = 578.83 from
Example:Il =N 2(.20)(.10)
Equation 2.

C
 - 20 -

represent desired inventory policy. Since most companies report

inventory status by stocking location on a regular basis, it is a

simple matter to track the execution of the inventory policy.

Should the actual and the desired inventory relationships diverge

beyond acceptable limits, corrective action would be indicated.

Summary

It has been the intent of this article to show that a polynomial

N
equation of the form IT =.I.(w+mD.+aD.b) can be an effective tool for
11
1=1
estimating the level of inventories on a by-product group basis for

a varying number of stocking points in a distribution system. Per-

haps more importantly, it has shown that for companies using a pull-

type inventory control system with control procedures based on sta-

tistical inventory control procedures the formula will be a power
function with an exponent ranging between 0.65 and 0.75. Deviations

from this are indications of poorly executed policies, policies tied

more directly to demand such that economies of scale are not present,

or a push strategy, volume buying, or production overruns dominate

inventory management. Also, we would expect this exponent to be
- -- no ]:owe-r than ·-0.5 -nor-higher_than 1_. 0. _ Thus, knqwing the nature of

a company's inventory policy, an estimating equation can be fashipned.

In addition, this simple formulation serves as a basis for auditing

and controlling inventories on an aggregate level.

The model fills a need in inventory theory that traditionally

has focused on item-by-item models rather than on aggregate models

for overall network inventory analysis. Distribution and production

planning often require an assessment of the impact that changes in

 - 21 -

warehouse configuration and the number of locations have on in-

ventory levels. Also, changes in inventory stocking policies need

to be evaluated broadly when considered in light of their impact

on transportation mode choices, production schedules, and the like.

The data for the model are readily obtained from the normal

operating data for a company such as from periodic stock status

reports. Only information on invdntory levels and stocking point
throughput (demand) is required, and a knowledge of the inventory

policy being implemented.

The model form is quite simple but surprisingly effective. It

is sure to be incorporated into many future auditing and strategic

planning analyses. It already has had repeated application in

warehouse location studies.

1 -I---
 - 22 -

End Notes

1Robert G. House and George C. Jackson, "Trends in Computer

Applications in Transportation and Distribution Management,"
International Journal of Physical Distribution, Vol. 7, No. 3
(1977), pp. 176-187

2 This formula is slightly more restrictive for illustrative purposes

than that developed in the appendix.

3
William J. Baumol and Philip Wolfe, "A Warehouse-Location Problem,"
Operations Research, Vol. 6 (March-April, 1958), pp. 252-63, and
Robert G. Brown, Decision Rules for Inventory Management (New York:
Holt, Rinehart and Winston, 1967), p. 353.

4Bernard J. LaLonde and Douglas M. Lambert, "A Methodology for

Determining Inventory Carrying Costs: Two Case Studies" (Supplement
in Proceedings of the Fifth Annual Transportation and Logistics
Educators Conference, ed. James F. Robeson and Johd 4. Grabner,
Chicago, October 12, 1975).

i
 - 23 -

APPENDIX

Derivation of an Aggregate Inventory Estimating Equation

The aggregate inventory estimating equation has its theoretical

underpinnings in inventory theory. Consider how it is developed.

Regular Stock
Regular stock is that amount of inventory to meet average demand
over the period of time from one stock replenishment to the next.
Based on the Wilson EOQ formulation, regular stock in a warehouse

for the jth item is, on the average

I d.S '
(RS).=1 J (A. 1)
3 32KC

where

(RS) = Average regular stock for item j, units.

d. = Annual demand for item j, units/year
J

S = Procurement cost, $/order.

K = Inventory carrying cost, % of item value per year.

C. = Item value for item j, $/unit.
J

- Assuming all -items-in a warehouse- have the--same K and S,--and C

represents the average value for the product class, the total regular

stock for n items in a warehouse -Ls:

n
#L (RN2KC
j=1
s)j-·J=1FF 3 7 (2)
J
 - 24 -

If D.
1
is the total demand_(throughput) on warehouse i, then
n Sni r--
n ID (A. 3)
I CRS):
j=l J =3 i i, ,1 Ei ='121[(E '1 i
If all warehouses contain roughly the same number of items for a
: particular product class , the total regular stock equation can be

approximated as

IRSi. = a- (A.4)

Since various inventory policies can prevail besides the Wilson EOQ,
the above equation can more generally be represented as

IRS, = aDb (A.5)

11

Safety Stock

Safety stock determination under a reorder point type of

inventory control system requires estimating the standard deviation

of the demand during lead time distribution. This has been shown
by Brown2 to be

SDDLT
- 222'
V= LTSD +d jSL T (A. 5)

when both lead time and demand are normally distributed; where
SDDLT standard deviation during lead time, units.

LT_ =__average_lead time, years..

S- = standard deviation of lead time, years.
LT

SD = standard deviation of demand, units.

% A product class might be all high volume items or conversely all

low volume items. The number of warehouses would likely be
different for each.

2
Robert G. Brown, Smoothing, Forecasting and Prediction of Discrete
Time Series (Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1962),
pp. 366-367.
./ I.
- 25 -

The standard deviation of demand has been reasonably approximate

hdg (A. 6)
SD =
where g has been observed to range from 0.6 to 1.0.
If Z. is the number of standard deviations on a normal distri-
J

bution curve representing the service level for item j, the safety
stock for all items in a warehouse is
n n 0.5
jil (ss)j -iil zj [LT(hd )2 + diSt ] (A. 7)

Further, if g=1 and Z.

J
is the same for all products in the product
class, and factoring out d.,
J

I (ss)j = Z(LTh + S T)0.5D i (A. 8)

j=1

More simply, the total safety stock is represented by

ISS.
1
= mDi (A. 9)

Note that if g is less than 1, the effect of safety stock will become
incorporated in the regular stock term.
Other Stocks
Additions may be made to inventories in the form of speculative

stodks, promotional stock, and production overruns. These stocks

- can be represented by
n
(A. 10)
w =jll Tj

where T. is the added stock for item j in a warehouse.

J

8
 - 26 -

Conclusion

The total stock in a warehouse is the sum of regular stocks,

safety stocks, and other stocks. Hence, the total stock I.1 in
warehouse i is

I.
1
= other stock + safety stock + regular stock
+I
RS..
= w + Iss.11
b
= w + mD. + aD .. (A. 11)
11

For the entire network of warehouses N, the total system inventory is

N
(A. 12)
IT =.I
1=1
Ii

The constants w, m, a, and b can be determined empirically from

warehouse throughput and inventory level data. The exact form of the
simplified equation for the inventory in a single warehouse accounts
for the fact that the Wilson EOQ model may not be used to set regular
stock levels, the lead time distribution may not be strictly normally

distributed, there may not be an identical number of number of items

in each warehouse, and the service level may not be exactly the same
for all items in a warehouse even within the same product class.

Empirical determination of the constants may result in one or more of

the terms being combined for the best estimation.