306 scm unit ii revised 1

7/29/2019 306 Scm Unit II Revised 1

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LSM-306 Supply Chain Management

Master of Business Administration

(Logistics & Supply Chain Management)

Supply Chain Management

SCM - 306


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GITAM INSTITUTE OF INTERNATIONAL BUSINESS Professor P.R.S SARMA M.B.A & Ph.D. - IITD

UNIT

-II


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What is INVENTORY?


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What is INVENTORY?

stocks of

ready made goods or raw materials

.. that are needed to be kept in order to be able to

meet the orders of clients


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Why Is Inventory Required?

Uncertainty in customer demand Shorter product lifecycles

More competing products

Uncertainty in supplies

Quality/Quantity/Costs/Delivery Times

Delivery lead times

Incentives for larger shipments


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Inventory

Optimization

No Idle

Inventories

No ShortageOf

Inventories

Why Is Inventory Required? (2)


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ShortageOf

Inventories

Break in Production process

Fail to reach to market in time

Loss of Productivity

Reduced levels commitment toCustomers



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Idle

Inventories

Accumulation of inventories =Increased capital cost

Increased indirect costs towardsstorage, safety etc

Obsolescence of inventory



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Holding the right amount at the right time is difficult!

Dell Computers was sharply off in its forecast of demand,

resulting in inventory write-downs

1993 stock plunge

Liz Claibornes higher-than-anticipated excess inventories 1993 unexpected earnings decline,

IBMs ineffective inventory management

1994 shortages in the ThinkPad line

Ciscos declining sales

2001 $ 2.25B excess inventory charge


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Inventory Management-Demand Forecasts

Uncertain demand makes demand forecast critical forinventory related decisions:

What to order?

When to order?

How much is the optimal order quantity?

Approach includes a set of techniques

INVENTORY POLICY!!


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Supply Chain Factors in Inventory Policy

Estimation of customer demand Replenishment lead time

The number of different products being considered

The length of the planning horizon

Costs Order cost:

Product cost

Transportation cost

Inventory holding cost, or inventory carrying cost: State taxes, property taxes, and insurance on inventories

Maintenance costs

Obsolescence cost

Opportunity costs

Service level requirements


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Typical Inventory positions .

. in Supplier-Manufacturer-Intermediary-consumer channel

WIPInventory

FG Inv.At plant

FG Inv.At field

RetailInventory

Consumer

Inventory

Re-work/re-packof product

RMInventory

Wastedisposal

Source: Duglas & James


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Toyota calling back cars with sticking pedal

Thursday 26th November, 2009

Toyota has decided to order its dealers to alter a part inaccelerator pedals on 3.8 million already recalled vehicles in theUS.

In September, the car giant advised drivers to remove their floormats after warning the pedals could become jammed under it.

Now, dealers have been told to shorten the accelerator pedalswhile Toyota manufactures a full replacement pedal.

The pedal fault has been blamed for at least one fatal accidentinvolving a Lexus ES350 that killed a California Highway Patrolofficer and three members of his family.


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Types of Inventory

Cycle Stock required to meet demand under conditions ofcertainty

In-transit Inventories part of cycle stock (but en route fromone location to other) though not available for sale and/or

shipment Safety or Buffer stock is in excess of cycle stock because of

uncertainty in demand or lead times

Speculative stock inventory held for reasons other thansatisfying current demand

Seasonal Stock a form of speculative stock involvingaccumulation of inventory before beginning of a season

Dead Stock set of products for which no demand registeredfor a specified period of time


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Effect of Reorder Qty on Average Inventory Investment withConstant Demand and Lead time


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Demand Uncertainty


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Effect of Demand Uncertainty

Firms to remember the following principles:

The forecast is always wrong

It is difficult to match supply and demand

The longer the forecast horizon, the worse the forecast

It is even more difficult if one needs to predict customer demand fora long period of time

Aggregate forecasts are more accurate.

More difficult to predict customer demand for individual (Stock-

Keeping Units) SKUsMuch easier to predict demand across all SKUs within one productfamily


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Inv. Management under conditions of Certainty

Replenishment policy under conditions of certainty requires balancing of

ordering costs against inventory costs

Ordering costs: sourcing from an outside supplier

Costs of Transmitting the order

Costs of receiving productCosts of placing product in storage

Costs associated with processing invoice for payment

Ordering costs: sourcing from is own field storeCosts of Transmitting and processing the inventory transfer

Costs of handling product

Costs of receiving product at field location

Costs of associated documentationNote: Remember that only direct out-of-pocket expenses should be included.


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Cost trade-offs required to determine the mostEconomical Order Quantity

0

20

40

60

80

100

120

140

160

0 500 1000 1500

Order Quantity

Cos

t

(Number of Units)

($)

Total Cost

Ordering Cost

Inv. carrying Cost


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Assumptions

P = Ordering cost

Q items per order: Order quantities are fixed, i.e., each time

the warehouse places an order, it is for Q items.

D = Demand per annum (number of units)

C = Annual inventory carrying cost accrued per unit held ininventory per day that the unit is held (also known as, holding

cost) as a % of product cost

V = Average cost of one unit of inventory


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Deriving EOQ

Total Annual cost (TAC) = (V x C x Q/2) + (P x (D/Q))

(I.C. cost) (Ord. cost)

dTAC = d(V x C x Q/2) + d(P x (D/Q))

dQ dQ dQ

dTAC = VC/2 + (PD (-Q-2))

dQ

=VC/2 PD/Q2

Setting VC/2 PD/Q2 = 0

VC/2 = PD/Q2

Q2 = 2PD/VC

Q =

h

KDQ

2*= 2PD/VC


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Effect of Reorder Qty on Average Inventory Investment withConstant Demand and Lead time


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EOQ: Example

h

KD

Q

2*=

2PD/VC

Let us determine the best ordering policy :

P = Ordering cost = $ 40D = Demand per annum = 4,800 unitsC = Annual inventory carrying cost accrued per unit held ininventory per day that the unit is held = 25 % of productcostV = Average cost of one unit of inventory = $ 100 per unit

Q* =

Q*=

h

KDQ

2*=

2(40) (4800)---------------0.25 x 100

Q*= 124 units

h

KDQ

2*=

3,84,000---------------

25


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5,480.005,000.00480.0012400

4,390.003,750.00640.0016300

3,460.002,500.00960.0024200

3,200.002,000.001,200.0030160

3,110.001,750.001,360.0034140

3,100.001,500.001,600.0040120

3,170.001,250.001,920.0048100

3,400.001,000.002,400.006080

3,950.00750.003,200.008060

5,300.00500.004,800.0012040

P = $ 40D = 4800 nos.

(Q/2 x C x V)P x (D/Q)(D/Q)(Q)

Total cost ($)Inventory carrying

cost ($)

Ordering cost ($)No. of OrdersOrder Qty.

Cost trade-offs required to determine the most Economical OrderQuantity


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Sensitivity Analysis

25%8.9%1.6%.4%00.5%2.5%25%Increase

in cost

21.51.21.11.9.8.5b

Total inventory cost relatively insensitive to order quantities

Actual order quantity: QQis a multiple bof the optimal order quantity Q*.For a given b, the quantity ordered is Q= bQ*


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Assumptions to EOQ Model

A continuous and constant and known rate of demand

A constant and known replenishment or lead time

A constant purchase price that is independent of order

quantity or time

No stock-outs are permitted

Only one item in inventory

An infinite planning horizon

No limit on capital availability


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Adjustments to EOQ

Adjustments need to be made to include:

Volume of transportation costs and

Quantity discounts


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Adjustments to EOQ (2)

Q1 = Maximum quantity that can be economically ordered to qualify for a

discount on unit cost

r = Percentage of price reduction if a larger quantity is ordered

D = Demand per annum (number of units)

C = Annual inventory carrying cost accrued per unit held in inventory per

day that the unit is held (also known as, holding cost) as a % of product

cost

Q0 = EOQ based on current price

Q1 = 2(r D/C) + (1-r) Q0


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3. Orders weighing 40000 or more lbs (1600 cases) have a rate of $ 3.64/cwt, which is = $0.91 per case

2. Orders weighing between 15000 lbs and 39000 lbs (600 cases and 1560 cases) have a rate of $ 3.90/cwt, which is = $0.975 percase

1. Orders for less than 15000 lbs (15000/25=600 cases) have a rate of $ 4.00/cwt, which is = $1 per caseGiven:

16,868222814,560801,820128,00016,000.0082000

16,837200514,742901,638129,60014,400.009180016,442178214,5601001,456128,00012,800.00101600

17,866134616,3801401,170134,4009,600.00141200

16,69889815,600200780128,0006,400.0020800

16,85045016,000400400128,0003,200.0040400

17,19842816,340430380130,7203,040.0043380

17,07833816,200540300129,6002,400.0054300

(F+G+H)1/2(C+E)25%(B) x (E)(B) x $10(B) x ( C)(A) x $8

Total

annualcost ($)

Inv. Carrying

cost ($)

Annual

transp.Cost ($)

Annual

Ord. cost($)

Transportati

oncost/order

($)

Value of

orders/Yr ($)

Purchase

price/order ($)

No.

ofOrders/Yr

Order

Qty.

(I)(H)(G)(F)(E)(D)( C )(B)(A)

Cost trade-offs to determine the most Economical Order Quantity with transportation costsincluded


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I.M. under Uncertainty

Factors influencing forecast accuracy:

Economic conditions

Competitive actions

Changes in Govt. regulations

Market shifts

Changes in consumer buying patterns

Transit times may vary

More time may be required to assemble an order or wait for scheduled

production on one occasion than another occasion Inconsistent lead times for components and raw materials

Incapability of suppliers to respond to the demand changes


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I.M. under Uncertainty (2)

Importance of Order quantity

It influences number of orders

Consequently the number of times the firm is exposed to a potentialstock-out at the end each order cycle

Note: The point at which the order is placed is the primary determinant offuture ability to fill demand while waiting for replenishment stock


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I.M. under Uncertainty (3)

Fixed Order point - Fixed Order Quantity Model

Order is placed when inventory in hand and on the order reaches to apre-determined minimum level required to satisfy demand during ordercycle

Fixed Order Interval Model

compares current inventory with fore cast demand

places an order for the necessary quantity at regular specified time.. Facilitates combining orders for various items in a vendors line .there

by qualifying for :

Volume purchase discounts and freight consolidationsavings


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Forecasting


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Inventories and Customer service

Establishment of service level a safety stock policy

(Customer relation) (ability to continuous production)

really a matter of managerial judgment.

Customer service levels should not be improved solely by addition ofinventories


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Inventories and Customer service (2)

Establishment of more economical policy:

(i) To stock highest volume products at retail locations

(ii) To stock high-moderate volume products at field-ware house locations

(iii) To stock slow-moving products at centrlised-locations (may be distributioncentre or a plant ware house)


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Symptoms of poor Inventory

Increasing number of back orders

Increasing investment in inventory with back orders remaining constant

High customer turnout

Increasing number of orders being cancelled

Wide variance in inventory turnover among distribution centers and among

major inventory items

Deteriorating relationships with intermediaries, as typified by dealercancellations and declining orders

Large quantities of obsolete items


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Steps to reduce Inventory levels

Multi-echelon inventory planning (Ex: ABC Analysis)

Lead time analysis

Elimination of obsolete items

Analysis of pack size and discount structure

Measurement of fill rates (magnitude of the stock-out situation) by SKUs

Analysis of customer demand characteristics

Note: The best method of reducing inventory investment is to reduce order-

cycle time by using advanced order processing systems


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ABC Analysis

Logic behind ABC Analysis:

20% of firms customers or products account for 80% of the sales (maybe a larger % of profits)

Steps in ABC analysis:

Rank products by sales or preferably by contributing to profitability

Check for differences between high-volume and low-volume items

GITAM INSTITUTE OF INTERNATIONAL BUSINESS P f P R S SARMA


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Sales history for Market Area -1

A

B

C

GITAM INSTITUTE OF INTERNATIONAL BUSINESS Professor P R S SARMA


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ABC Analysis (3)

A Items:

Continuous review of inventory status is appropriate

May be stocked at all ware houses

Customer service level: Order fill rate of 98%

B Items

May be reviewed weeklyMay be stocked at regional warehouses


C Items

May be least attention

May be stocked only at the factory


Note: Though transportation costs for B & C items are greater, inventory reductions

are more.

Resulting overallCustomer serviceLevel of 95%



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Target inventory level = 95% across all products.

Service level > 99% for many products with high profit margin, high

volume and low variability.

Service level < 95% for products with low profit margin, low volume and

high variability.

Profit Optimization and Service Level



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Forecasting

is an important aspect of aspect of I.M.

Developed at the total company or product level

Down to product class and SKUs (based on past sales history)

Down to central Distribution center to branch/regional distribution centersusing one of the following methods:

Going rate rate of sales that the SKU is experiencing at each location

Weeks/months of supply the number of weeks/months of sales based on

expected future sales that management wishes to hold at each location

Available inventory currently available inventory less back orders

GITAM INSTITUTE OF INTERNATIONAL BUSINESS Professor P.R.S SARMA M B A & Ph D IITD


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Forecasting

RULES OF FORECASTING

The forecast is always wrong.

The longer the forecast horizon, the worse the forecast.

Aggregate forecasts are more accurate.

GITAM INSTITUTE OF INTERNATIONAL BUSINESS Professor P.R.S SARMA M B A & Ph D IITD


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GITAM INSTITUTE OF INTERNATIONAL BUSINESS M.B.A & Ph.D. - IITD

Utility of Forecasting

Part of the available tools for a manager

Despite difficulties with forecasts, it can be used for a variety of decisions

Number of techniques allow prudent use of forecasts as needed



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M.B.A & Ph.D. IITD

Techniques

Judgment Methods

Sales-force composite

Experts panel

Delphi method

Market research/survey

Time Series Moving Averages

Exponential Smoothing

Trends

Regression

Holts method

Seasonal patterns Seasonal decomposition

Trend + Seasonality Winters Method

Causal Methods



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The Most Appropriate Technique (s)

Purpose of the forecast

How will the forecast be used?

Dynamics of system for which forecast will be made

How accurate is the past history in predicting the future?



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SUMMARY

Matching supply with demand a major challenge

Forecast demand is always wrong

Longer the forecast horizon, less accurate the forecast

Aggregate demand more accurate than disaggregated demand

Need the most appropriate technique

Need the most appropriate inventory policy



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Risk Pooling

Demand variability is reduced if one aggregates demand

across locations.

More likely that high demand from one customer will be

offset by low demand from another.

Reduction in variability allows a decrease in safety stock andtherefore reduces average inventory.



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Demand Variation

Standard deviation measures how much demand tends to vary around the

average

Gives an absolute measure of the variability

Coefficient of variation is the ratio of standard deviation to average

demand

Gives a relative measure of the variability, relative to the averagedemand



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306 scm unit ii revised 1

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