1

Inventory Management
Using Analytics for Better Decisions
2
Why We Want to Hold Inventories
Improve customer service
Reduce certain costs such as
ordering costs
stockout costs
acquisition costs
start-up quality costs
Contribute to the efficient and effective operation of
the production system
3
Why We Want to Hold Inventories
Finished Goods
Essential in produce-to-stock positioning strategies
Necessary in level aggregate capacity plans
Products can be displayed to customers
Work-in-Process
Necessary in process-focused production
May reduce material-handling & production costs
Raw Material
Suppliers may produce/ship materials in batches
Quantity discounts and freight/handling lead to
savings
4
Why We Do Not Want to Hold Inventories
Certain costs increase such as
carrying costs
cost of diluted return on investment
reduced-capacity costs
large-lot quality cost
cost of production problems
5
Why We Do Not Want to Hold Inventories
Difficult to Control
Hides Production problems
6
Trade-offs
Lot-size Inventory (Bullwhip effect)
Inventory Transportation (Ordering/Setup) cost
Lead Time Transportation cost
Product variety Inventory
Cost Customer service
7
How do we know we have a good inventory
management system?
8
Effective Inventory Management
A system to keep track of inventory
A reliable forecast of demand
Knowledge of lead time
Reasonable estimate of
- Holding cost
- Ordering cost
- Shortage cost
A classification system
9
Nature of Inventory
Two Fundamental Inventory Decisions
Terminology of Inventories
Independent Demand Inventory Systems
Dependent Demand Inventory Systems
Inventory Costs
10
Two Fundamental Inventory Decisions
How much to order of each material when orders are
placed with either outside suppliers or production
departments within organizations
When to place the orders
11
Independent Demand Inventory Systems
Demand for an item carried in inventory is
independent of the demand for any other item in
inventory
Finished goods inventory is an example
Demands are estimated from forecasts and/or
customer orders
12
Dependent Demand Inventory Systems
Items whose demand depends on the demands for
other items
For example, the demand for raw materials and
components can be calculated from the demand for
finished goods
The systems used to manage these inventories are
different from those used to manage independent
demand items
13
Inventory Costs
Costs associated with ordering too much (represented
by carrying costs)
Costs associated with ordering too little (represented
by ordering costs)
These costs are opposing costs, i.e., as one increases
the other decreases
. . . more
14
Carrying cost
Obsolescence
Insurance
Extra staffing
Interest
Pilferage
Damage
Warehousing
Etc.
15
Carrying Cost
(Approximate ranges)
Category Cost as % of
Inventory Value
Investments costs 11%
(6 24%)
Labour cost from extra handling 3%
(3 5%)
Housing cost 6%
(3 10%)
Other costs also range between 1 5%.
16
Ordering cost
Processing Supplies
Forms
Order processing
Clerical support
Etc.
17
Set-up costs
Clean-up cost
Re-tooling cost
Adjustment cost
Etc.

18
Inventory Costs (continued)
The sum of the two costs is the total stocking cost
(TSC)
When plotted against order quantity, the TSC
decreases to a minimum cost and then increases
This cost behavior is the basis for answering the first
fundamental question: how much to order
It is known as the economic order quantity (EOQ)
19
Balancing Carrying against Ordering Costs
Annual Cost ($)
Order Quantity
Minimum
Total Annual
Stocking Costs
Annual
Carrying Costs
Annual
Ordering Costs
Total Annual
Stocking Costs
Smaller Larger
L
o
w
e
r

H
i
g
h
e
r

EOQ
20
Fixed Order Quantity Systems
Behavior of Economic Order Quantity (EOQ)
Systems
Determining Order Quantities
Determining Order Points
21
Behavior of EOQ Systems
As demand for the inventoried item occurs, the
inventory level drops
When the inventory level drops to a critical point, the
order point, the ordering process is triggered
The amount ordered each time an order is placed is
fixed or constant
When the ordered quantity is received, the inventory
level increases
. . . more
22
Behavior of EOQ Systems
An application of this type system is the two-bin
system
Two bin system: Two containers of inventory; order
when one is empty

A perpetual inventory accounting system is usually
associated with this type of system
Perpetual inventory system: System that keeps track
of removals from inventory continuously; thus
monitoring current levels of each item.
23
Determining Order Quantities
Basic EOQ
EOQ for Production Lots
EOQ with Quantity Discounts
24
Model I: Basic EOQ
Typical assumptions made
annual demand (D), carrying cost (C) and ordering
cost (S) can be estimated
average inventory level is the fixed order quantity
(Q) divided by 2 which implies
no safety stock
orders are received all at once
demand occurs at a uniform rate
no inventory when an order arrives
. . . more
25
Model I: Basic EOQ
Assumptions (continued)
Stockout, customer responsiveness, and other costs
are inconsequential
acquisition cost is fixed, i.e., no quantity discounts
Annual carrying cost = (average inventory level) x
(carrying cost) = (Q/2)C
Annual ordering cost = (average number of orders per
year) x (ordering cost) = (D/Q)S
. . . more
26
C DS / 2 = EOQ
Model I: Basic EOQ
Total annual stocking cost (TSC) = annual carrying
cost + annual ordering cost = (Q/2)C + (D/Q)S
The order quantity where the TSC is at a minimum
(EOQ) can be found using calculus (take the first
derivative, set it equal to zero and solve for Q)

27
Example: Basic EOQ
Zartex Co. stocks fertilizer to sell to retailers. One item calcium nitrate
is purchased from a nearby manufacturer at Rs. 22.50 per ton. Zartex
estimates it will need 5,750,000 tons of calcium nitrate next year.
The annual carrying cost for this material is 40% of the acquisition
cost, and the ordering cost is Rs. 595.
a) What is the most economical order quantity?
b) How many orders will be placed per year?
c) How much time will elapse between orders?
28
Example: Basic EOQ
Economical Order Quantity (EOQ)

D = 5,750,000 tons/year
C = .40(22.50) = Rs. 9.00/ton/year
S = Rs. 595/order



= 27,573.135 tons per order
EOQ = 2DS/C
EOQ = 2(5,750,000)(595)/9.00
29
Example: Basic EOQ
Total Annual Stocking Cost (TSC)
TSC = (Q/2)C + (D/Q)S
= (27,573.135/2)(9.00)
+ (5,750,000/27,573.135)(595)
= 124,079.11 + 124,079.11
= Rs.248,158.22
Note: Total Carrying Cost
equals Total Ordering Cost
30
Example: Basic EOQ
Number of Orders Per Year
= D/Q
= 5,750,000/27,573.135
= 208.5 orders/year
Time Between Orders
= Q/D
= 1/208.5
= .004796 years/order
= .004796(365 days/year) = 1.75 days/order
Note: This is the inverse
of the formula above.
31
Model II: EOQ for Production Lots
Used to determine the order size, production lot, if an
item is produced at one stage of production, stored in
inventory, and then sent to the next stage or the
customer
Differs from Model I because orders are assumed to
be supplied or produced at a uniform rate (p) rate
rather than the order being received all at once
. . . more
32
Model II: EOQ for Production Lots
It is also assumed that the supply rate, p, is greater
than the demand rate, d
The change in maximum inventory level requires
modification of the TSC equation
TSC = (Q/2)[(p-d)/p]C + (D/Q)S
The optimization results in
(

d p
p
C
DS 2
= EOQ
33
Example: EOQ for Production Lots
Highland Electric Co. buys coal from Cedar
Creek Coal Co. to generate electricity. CCCC can
supply coal at the rate of 3,500 tons per day for
$10.50 per ton. HEC uses the coal at a rate of 800
tons per day and operates 365 days per year.
HECs annual carrying cost for coal is 20% of the
acquisition cost, and the ordering cost is $5,000.
a) What is the economical production lot size?
b) What is HECs maximum inventory level for coal?
34
Example: EOQ for Production Lots
Economical Production Lot Size

d = 800 tons/day; D = 365(800) = 292,000 tons/year
p = 3,500 tons/day
S = $5,000/order C = .20(10.50) = $2.10/ton/year



= 42,455.5 tons per order

EOQ = (2DS/C)[p/(p-d)]
EOQ = 2(292,000)(5,000)/2.10[3,500/(3,500-800)]
35
Example: EOQ for Production Lots
Total Annual Stocking Cost (TSC)
TSC = (Q/2)((p-d)/p)C + (D/Q)S
= (42,455.5/2)((3,500-800)/3,500)(2.10)
+ (292,000/42,455.5)(5,000)
= 34,388.95 + 34,388.95
= $68,777.90

Note: Total Carrying Cost
equals Total Ordering Cost
36
Example: EOQ for Production Lots
Maximum Inventory Level
= Q(p-d)/p
= 42,455.5(3,500 800)/3,500
= 42,455.5(.771429)
= 32,751.4 tons Note: HEC will use 23%
of the production lot by the
time it receives the full lot.
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Key Points from EOQ Model
In deciding the optimal lot size, the tradeoff is between
setup (order) cost and holding cost.

If demand increases by a factor of 4, it is optimal to
increase batch size by a factor of 2 and produce (order)
twice as often. Cycle inventory (in days of demand)
should decrease as demand increases.

If lot size is to be reduced, one has to reduce fixed order
cost. To reduce lot size by a factor of 2, order cost has
to be reduced by a factor of 4.
38
Model III: EOQ with Quantity Discounts
Under quantity discounts, a supplier offers a lower
unit price if larger quantities are ordered at one time
This is presented as a price or discount schedule, i.e.,
a certain unit price over a certain order quantity range
This means this model differs from Model I because
the acquisition cost (ac) may vary with the quantity
ordered, i.e., it is not necessarily constant
. . . more
39
All-Unit Quantity Discounts
Pricing schedule has specified quantity break points
q
0
, q
1
, , q
r
, where q
0
= 0
If an order is placed that is at least as large as q
i
but
smaller than q
i+1
, then each unit has an average unit
cost of C
i

The unit cost generally decreases as the quantity
increases, i.e., C
0
>C
1
>>C
r

The objective for the company (a retailer in our
example) is to decide on a lot size that will
minimize the sum of material, order, and holding
costs
40
Model III: EOQ with Quantity Discounts
Under this condition, acquisition cost becomes an
incremental cost and must be considered in the
determination of the EOQ
The total annual material costs (TMC) = Total annual
stocking costs (TSC) + annual acquisition cost

TSC = (Q/2)C + (D/Q)S + (D)ac

. . . more
41
All-Unit Quantity Discounts: Example
Cost/Unit
Rs. 3
Rs. 2.96
Rs.2.92
Order Quantity
5,000 10,000
Order Quantity
5,000 10,000
Total Material Cost
42
Model III: EOQ with Quantity Discounts
To find the EOQ, the following procedure is used:
1. Compute the EOQ using the lowest acquisition cost.
If the resulting EOQ is feasible (the quantity can
be purchased at the acquisition cost used), this
quantity is optimal and you are finished.
If the resulting EOQ is not feasible, go to Step 2
2. Identify the next higher acquisition cost.
43
Model III: EOQ with Quantity Discounts
3. Compute the EOQ using the acquisition cost from
Step 2.
If the resulting EOQ is feasible, go to Step 4.
Otherwise, go to Step 2.
4. Compute the TMC for the feasible EOQ (just found
in Step 3) and its corresponding acquisition cost.
5. Compute the TMC for each of the lower acquisition
costs using the minimum allowed order quantity for
each cost.
6. The quantity with the lowest TMC is optimal.
44
All-Unit Quantity Discount: Example
Order quantity Unit Price
0-5000 Rs. 3.00
5001-10000 Rs. 2.96
Over 10000 Rs. 2.92

q0 = 0, q1 = 5000, q2 = 10000
C0 = Rs. 3.00, C1 = Rs. 2.96, C2 = Rs. 2.92
D = 120000 units/year, S = Rs. 100/lot,
h = 0.2

45
All-Unit Quantity Discount: Example
Step 1: Calculate Q2* = Sqrt[(2DS)/hC2]
= Sqrt[(2)(120000)(100)/(0.2)(2.92)] = 6410
Not feasible (6410 < 10001)
Calculate TC2 using C2 = Rs. 2.92 and q2 = 10001
TC2 = (120000/10001)(100)+(10001/2)(0.2)(2.92)+(120000)(2.92)
= Rs. 354,520
Step 2: Calculate Q1* = Sqrt[(2DS)/hC1]
=Sqrt[(2)(120000)(100)/(0.2)(2.96)] = 6367
Feasible (5000<6367<10000) Stop
TC1 = (120000/6367)(100)+(6367/2)(0.2)(2.96)+(120000)(2.96)
= Rs. 358,969
TC2 < TC1 The optimal order quantity Q* is q2 = 10001

46
Example: EOQ with Quantity Discounts
A-1 Auto Parts has a regional tire warehouse in
Atlanta. One popular tire, the XRX75, has estimated
demand of 25,000 next year. It costs A-1 $100 to
place an order for the tires, and the annual carrying
cost is 30% of the acquisition cost. The supplier
quotes these prices for the tire:
Q ac
1 499 $21.60
500 999 20.95
1,000 + 20.90
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Example: EOQ with Quantity Discounts
Economical Order Quantity



This quantity is not feasible, so try ac = $20.95


This quantity is feasible, so there is no reason to try
ac = $21.60

i i
EOQ = 2DS/C
3
EOQ = 2(25,000)100/(.3(20.90) = 893.00
2
EOQ = 2(25,000)100/(.3(20.95) = 891.93
48
Example: EOQ with Quantity Discounts
Compare Total Annual Material Costs (TMCs)
TMC = (Q/2)C + (D/Q)S + (D)ac
Compute TMC for Q = 891.93 and ac = $20.95
TMC
2
= (891.93/2)(.3)(20.95) + (25,000/891.93)100
+ (25,000)20.95
= 2,802.89 + 2,802.91 + 523,750
= $529,355.80
more
49
Example: EOQ with Quantity Discounts
Compute TMC for Q = 1,000 and ac = $20.90
TMC
3
= (1,000/2)(.3)(20.90) + (25,000/1,000)100
+ (25,000)20.90
= 3,135.00 + 2,500.00 + 522,500
= $528,135.00 (lower than TMC
2
)

The EOQ is 1,000 tires
at an acquisition cost of $20.90.
50
Dynamics of Inventory Planning
Continually review ordering practices and decisions
Modify to fit the firms demand and supply patterns
Constraints, such as storage capacity and available
funds, can impact inventory planning
Computers and information technology are used
extensively in inventory planning
51
Inventory cycle is the central focus of independent
demand inventory systems
Production planning and control systems are
changing to support lean inventory strategies
Information systems electronically link supply chain
52
Planning Supply Chain Activities
Anticipatory - allocate supply to each
warehouse based on the forecast








Response-based - replenish inventory with
order sizes based on specific needs of each
warehouse
53
Integrated planning at Shell
The most successful e-supply initiatives so far have been in
industries where the components converge to create a product and
where prices are not volatile. Energy is different. The supply
chain is divergent; there are more products than raw materials and
prices are highly volatile. Shell understands this and is aiming to
create a reliable, real time, multi-point-optimized, an overview of
entire supply chain..
Across the globe this initiative has the potential to generate new
value and drive savings to the tune of multiple of million US
dollars a day.
- A vice president of Shell Oil Products
54
Integrated planning at Shell
Requirements for IT toolsets:
Complete horizontal supply chain integration
Convergence of strategy, planning and scheduling
Modularity to enable phased implementation and customization
Scalability
Interactive
Convenient User-interfacing
Real time results
Direct links to online refinery / plant optimization


55
56
Determining Order Points
Basis for Setting the Order Point
DDLT Distributions
Setting Order Points

57
Basis for Setting the Order Point
In the fixed order quantity system, the ordering
process is triggered when the inventory level drops to
a critical point, the order point
This starts the lead time for the item.
Lead time is the time to complete all activities
associated with placing, filling and receiving the
order.
. . . more
58
Basis for Setting the Order Point
During the lead time, customers continue to draw
down the inventory
It is during this period that the inventory is vulnerable
to stockout (run out of inventory)
Customer service level is the probability that a
stockout will not occur during the lead time
. . . more
59
Basis for Setting the Order Point
The order point is set based on
the demand during lead time (DDLT) and
the desired customer service level
Order point (OP) = Expected demand during lead
time (EDDLT) + Safety stock (SS)
The amount of safety stock needed is based on the
degree of uncertainty in the DDLT and the customer
service level desired
60
DDLT Distributions
If there is variability in the DDLT, the DDLT is
expressed as a distribution
discrete
continuous
In a discrete DDLT distribution, values (demands)
can only be integers
A continuous DDLT distribution is appropriate when
the demand is very high
61
Setting Order Point
for a Discrete DDLT Distribution
Assume a probability distribution of actual DDLTs is
given or can be developed from a frequency
distribution
Starting with the lowest DDLT, accumulate the
probabilities. These are the service levels for DDLTs
Select the DDLT that will provide the desired
customer level as the order point
62
Example: OP for Discrete DDLT Distribution
One of Sharp Retailers inventory items is now being analyzed
to determine an appropriate level of safety stock. The manager
wants an 80% service level during lead time. The items
historical DDLT is:
DDLT (cases) Occurrences
3 8
4 6
5 4
6 2
63
OP for Discrete DDLT Distribution
Construct a Cumulative DDLT Distribution
Probability Probability of
DDLT (cases) of DDLT DDLT or Less
2 0 0
3 .4 .4
4 .3 .7
5 .2 .9
6 .1 1.0

To provide 80% service level, OP = 5 cases
.8
64
OP for Discrete DDLT Distribution
Safety Stock (SS)
OP = EDDLT + SS
SS = OP EDDLT
EDDLT = .4(3) + .3(4) + .2(5) + .1(6) = 4.0
SS = 5 4 = 1
65
The Role of Safety Inventory
in a Supply Chain
Forecasts are rarely completely accurate
If average demand is 1000 units per week, then half the
time actual demand will be greater than 1000, and half
the time actual demand will be less than 1000; what
happens when actual demand is greater than 1000?
If you kept only enough inventory in stock to satisfy
average demand, half the time you would run out
Safety inventory: Inventory carried for the purpose of
satisfying demand that exceeds the amount forecasted
in a given period
66
Role of Safety Inventory
Average inventory is therefore cycle inventory plus safety
inventory
There is a fundamental tradeoff:
Raising the level of safety inventory provides higher
levels of product availability and customer service
Raising the level of safety inventory also raises the
level of average inventory and therefore increases
holding costs
Very important in high-tech or other industries
where obsolescence is a significant risk (where the
value of inventory, such as PCs, can drop in value)
Compaq and Dell in PCs
67
Two Questions to Answer in Planning Safety
Inventory
What is the appropriate level of safety inventory
to carry?
What actions can be taken to improve product
availability while reducing safety inventory?
68
Determining the Appropriate
Level of Safety Inventory
Measuring demand uncertainty
Measuring product availability
Replenishment policies
Evaluating cycle service level and fill rate
Evaluating safety level given desired cycle service
level or fill rate
Impact of required product availability and
uncertainty on safety inventory
69
Determining the Appropriate
Level of Demand Uncertainty
Appropriate level of safety inventory determined
by:
supply or demand uncertainty
desired level of product availability
Higher levels of uncertainty require higher levels of
safety inventory given a particular desired level of
product availability
Higher levels of desired product availability require
higher levels of safety inventory given a particular
level of uncertainty
70
Measuring Demand Uncertainty
Demand has a systematic component and a random component
The estimate of the random component is the measure of
demand uncertainty
Random component is usually estimated by the standard
deviation of demand
Notation:
D = Average demand per period
o
D
= standard deviation of demand per period
L = lead time = time between when an order is placed
and when it is received
Uncertainty of demand during lead time is what is important
71
Measuring Demand Uncertainty
P = demand during k periods = kD
O = std dev of demand during k periods = o
R
Sqrt(k)
Coefficient of variation = cv = /o = mean/(std dev)
= size of uncertainty relative to demand

72
Measuring Product Availability
Product availability: a firms ability to fill a
customers order out of available inventory
Stockout: a customer order arrives when product is
not available
Product fill rate (fr): fraction of demand that is
satisfied from product in inventory
Order fill rate: fraction of orders that are filled from
available inventory
Cycle service level: fraction of replenishment cycles
that end with all customer demand met
73
Replenishment Policies
Replenishment policy: decisions regarding when to
reorder and how much to reorder
Continuous review: inventory is continuously
monitored and an order of size Q is placed when the
inventory level reaches the reorder point ROP
Periodic review: inventory is checked at regular
(periodic) intervals and an order is placed to raise the
inventory to a specified threshold (the order-up-to
level)
74
Continuous Review Policy: Safety Inventory
and Cycle Service Level
L: Lead time for replenishment
D: Average demand per unit
time
o
D:
Standard deviation of
demand per period
D
L
:

Mean demand during lead
time
o
L
: Standard deviation of
demand during lead time
CSL: Cycle service level
ss: Safety inventory
ROP: Reorder point
) , , (
) (
1
o
o
o o
L L
L
L S
D L
L
D
D
F
D
ROP F CSL
ss ROP
CSL ss
L
DL
=
+ =
=
=
=

Average Inventory = Q/2 + ss

75
Auto Zone sells auto parts and supplies including a
popular multi-grade motor oil. When the stock of
this oil drops to 20 gallons, a replenishment order is
placed. The store manager is concerned that sales
are being lost due to stockouts while waiting for an
order. It has been determined that lead time demand
is normally distributed with a mean of 15 gallons
and a standard deviation of 6 gallons.

The manager would like to know the probability of a
stockout during lead time.
Example: OP - Continuous DDLT Distribution
76
Example: OP - Continuous DDLT Distribution
EDDLT = 15 gallons
\o
DDLT
= 6 gallons

OP = EDDLT + Z(o
DDLT
)
20 = 15 + Z(6)
5 = Z(6)
Z = 5/6
Z = .833
77
Example: OP - Continuous DDLT Distribution
Standard Normal Distribution
0 .833
Area = .2967
Area = .5
Area = .2033
z
78
Example: OP - Continuous DDLT Distribution
The Standard Normal table shows an area of
.2967 for the region between the z = 0 line and the
z = .833 line. The shaded tail area is .5 - .2967 =.2033.
The probability of a stock-out during lead time is .2033
79
Setting Order Point
for a Continuous DDLT Distribution
The resulting DDLT distribution is a normal
distribution with the following parameters:

EDDLT = LT(d)

o
DDLT
= LT d ( ) o
2
80
Setting Order Point
for a Continuous DDLT Distribution
The customer service level is converted into a Z value using the normal
distribution table
The safety stock is computed by multiplying the Z value by o
DDLT
.
The order point is set using OP = EDDLT + SS, or by substitution

2
d
OP = LT(d) + z LT( )
81
Example
Q = 5;
d
= 1.5; SL = 95%

R = d + Z
d
= 5 + 1.645*1.5 = 5 + 2.5
= 7.5
Order 5 (Q) whenever the inventory level is below
7.5 (8).
So, what does this mean?


82
Example A: Estimating Safety Inventory
(Continuous Review Policy)
D = 2,500/week; o
D
= 500
L = 2 weeks; Q = 10,000; ROP = 6,000

D
L
= DL = (2500)(2) = 5000
ss = ROP - R
L
= 6000 - 5000 = 1000
Cycle inventory = Q/2 = 10000/2 = 5000
Average Inventory = cycle inventory + ss = 5000 + 1000 = 6000
Average Flow Time = Avg inventory / throughput = 6000/2500 =
2.4 weeks
83
Example B: Estimating Cycle Service Level
(Continuous Review Policy)
D = 2,500/week; o
D =
500
L = 2 weeks; Q = 10,000; ROP = 6,000



Cycle service level, CSL = F(D
L
+ ss, D
L
, o
L
) =
= NORMDIST (D
L
+ ss, D
L
, o
L
) = NORMDIST(6000,5000,707,1)
= 0.92 (This value can also be determined from a Normal
probability distribution table)
707 2 ) 500 ( = = = L
R L
o o
84
Impact of Supply Uncertainty
D: Average demand per period
o
D:
Standard deviation of demand per period
L: Average lead time
s
L
: Standard deviation of lead time

s D
D
L D L
L
L
DL
2 2 2
+ =
=
o o
85
Impact of Supply Uncertainty
D = 2,500/day; o
D =
500
L = 7 days; Q = 10,000; CSL = 0.90; s
L
= 7 days
D
L
= DL = (2500)(7) = 17500





ss = F
-1
s
(CSL)o
L
= NORMSINV(0.90) x 17550
= 22,491
17500 ) 7 ( ) 2500 (
500
) 7 (
2 2
2
2 2 2
= + =
+ =
s D
L
L
D
L
o
o
86
Impact of Supply Uncertainty
Safety inventory when s
L
= 0 is 1,695
Safety inventory when s
L
= 1 is 3,625
Safety inventory when s
L
= 2 is 6,628
Safety inventory when s
L
= 3 is 9,760
Safety inventory when s
L
= 4 is 12,927
Safety inventory when s
L
= 5 is 16,109
Safety inventory when s
L
= 6 is 19,298
87
Information Centralization
Virtual aggregation
Information system that allows access to current
inventory records in all warehouses from each
warehouse
Most orders are filled from closest warehouse
In case of a stockout, another warehouse can fill the
order
Better responsiveness, lower transportation cost,
higher product availability, but reduced safety
inventory
Examples: McMaster-Carr, Gap, Wal-Mart
88
Postponement
The ability of a supply chain to delay product
differentiation or customization until closer to the
time the product is sold
Goal is to have common components in the
supply chain for most of the push phase and
move product differentiation as close to the pull
phase as possible
Examples: Dell, Benetton
89
Impact of Replenishment
Policies on Safety Inventory
Continuous review policies
Periodic review policies
90
Estimating and Managing
Safety Inventory in Practice
Account for the fact that supply chain demand is
lumpy
Adjust inventory policies if demand is seasonal
Use simulation to test inventory policies
Start with a pilot
Monitor service levels
Focus on reducing safety inventories
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Setting Order Point
for a Continuous DDLT Distribution
Assume that the lead time (LT) is constant
Assume that the demand per day is normally distributed with
the mean (d ) and the standard deviation (o
d
)
The DDLT distribution is developed by adding together the
daily demand distributions across the lead time
. . . more
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Customer Service Criterion
The number of units short in one year (time period) is equal to the
percentage short times the annual demand.
(1 SL) * D
This is equal to the number of units short per order (
d
E(Z))
times the number of orders per year (time period).

d
E(Z) [D/Q]

SL =
d
E(Z)/Q
E(Z) = Q(1- SL)/
d

93
Example Text
Q = 5;
d
= 1.5 SL = 95%

E(Z) = Q(1 - .05)/
d
= 5*.05/1.5
= .167

From the tables Z = 0.6

R = d + Z
d
= 5 + 0.6*1.5 = 5 + 0.9 = 5.9
Order 5 when the inventory level reaches 5.9
94
Example
A service station is located right across campus. His gas sales have
been going down. To improve his sales he is considering
utilizing some available space to place some soda vending
machines. When he orders, he usually orders 10 cases (240
cans). He estimates that the daily demand can be approximated
by a Normal distribution with a mean of 75 cans and a standard
deviation of 10 cans. He also feels that an 85% (very
sophisticated gas station owner) service level would be
adequate. His soda supplier promises that his lead time will be
exactly 4 days.
a) What should his reorder point be?
b) What is the safety stock?
95
Solution in terms of probability of stock-out
a) N(75, 10) Time period correction factor
N(75*4, 104)
R = d + Z
d

= 4*75 + (1.04)*(10 4)
= 300 + 20.8 = 321

b) Safety Stock
SS = 20.8
96
Another Example
D = annual demand 1000 units LT=15days
Q = 200 units Service Level = 95 % (.95)
Working days/yr = 250
d
=50 units
Average demand/day=1000/250 = 4 units/day
R = d + Z
d
= 4*15 + Z(50)
E(Z)=(1-.95)200/50 = 0.2 from tables
Z = 0.49
R = 4(15) + 0.49*50 = 84.5
R = 4(15) + 1.645*50 = 142.25
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Example (Cont.)
Policy:
When inventory level gets to 85 or less then order 200.
What is the expected number of units short per order?
E(Z)
d
= 0.2 * 50 = 10
How many orders per year?
(1000/200)= 5
Total number of units short?
10*5 = 50 (Service level is 95%; 950/1000)