306 SCM Unit II Revised 1

Supply Chain Management
SCM - 306
LSM-306 Supply Chain Management
Master of Business Administration (Logistics & Supply Chain Management)
GITAM INSTITUTE OF INTERNATIONAL BUSINESS
Professor P.R.S SARMA M.B.A & Ph.D. - IITD
LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering
I N U
II T
What is INVENTORY?
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
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
5
Why Is Inventory Required? (2)

Inventory Optimization
No Idle Inventories
No Shortage Of Inventories

Break in Production process
Fail to reach to market in time Loss of Productivity Reduced levels commitment to Customers
Shortage Of Inventories

Accumulation of inventories = Increased capital cost Increased indirect costs towards storage, safety etc Obsolescence of inventory
Idle Inventories
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
Inventory Management-Demand Forecasts
Uncertain demand makes demand forecast critical for inventory related decisions: What to order? When to order? How much is the optimal order quantity? Approach includes a set of techniques INVENTORY POLICY!!
10
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

11
Typical Inventory positions .
. in Supplier-Manufacturer-Intermediary-consumer channel
WIP Inventory FG Inv. At plant
RM Inventory FG Inv. At field
Consumer Inventory Re-work/ re-pack of product
Retail Inventory
Waste disposal
Source: Duglas & James
12
Toyota calling back cars with sticking pedal

Thursday 26th November, 2009
Toyota has decided to order its dealers to alter a part in accelerator pedals on 3.8 million already recalled vehicles in the US. In September, the car giant advised drivers to remove their floor mats after warning the pedals could become jammed under it. Now, dealers have been told to shorten the accelerator pedals while Toyota manufactures a full replacement pedal. The pedal fault has been blamed for at least one fatal accident involving a Lexus ES350 that killed a California Highway Patrol officer and three members of his family.
13
Types of Inventory
Cycle Stock required to meet demand under conditions of certainty In-transit Inventories part of cycle stock (but en route from one 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 than satisfying current demand Seasonal Stock a form of speculative stock involving accumulation of inventory before beginning of a season Dead Stock set of products for which no demand registered for a specified period of time
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Effect of Reorder Qty on Average Inventory Investment with Constant 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 for a long period of time Aggregate forecasts are more accurate. More difficult to predict customer demand for individual (StockKeeping Units) SKUs Much easier to predict demand across all SKUs within one product family
17
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 product Costs of placing product in storage Costs associated with processing invoice for payment Ordering costs: sourcing from is own field store Costs of Transmitting and processing the inventory transfer Costs of handling product Costs of receiving product at field location Costs of associated documentation Note: Remember that only direct out-of-pocket expenses should be included.
18
Cost trade-offs required to determine the most Economical Order Quantity
160 140 120 C o s t ($) 100 80 60 40 20 0 0 500 1000

(Number of Units)
Total Cost Inv. carrying Cost Ordering Cost
1500
Orde r Quantity
19
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 in inventory 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
20
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=
Q =
2 KD 2PD/VC h
21
Effect of Reorder Qty on Average Inventory Investment with Constant Demand and Lead time
22
EOQ: Example
Let us determine the best ordering policy :

P = Ordering cost = $ 40 D = Demand per annum = 4,800 units C = Annual inventory carrying cost accrued per unit held in inventory per day that the unit is held = 25 % of product cost V = Average cost of one unit of inventory = $ 100 per unit
* Q* =
Q =
2 KD 2PD/VC h 2 KD 3,84,000 Q = --------------h 25

*
23
Q*=
Q =
2(40) (4800) --------------0.25 x 100
2 KD h
Q*= 124 units
Cost trade-offs required to determine the most Economical Order Quantity

Order Qty. No. of Orders (D/Q) D = 4800 nos. 40 60 80 100 120 140 160 200 300 400 120 80 60 48 40 34 30 24 16 12 Ordering cost ($) P x (D/Q) P = $ 40 4,800.00 3,200.00 2,400.00 1,920.00 1,600.00 1,360.00 1,200.00 960.00 640.00 480.00 500.00 750.00 1,000.00 1,250.00 1,500.00 1,750.00 2,000.00 2,500.00 3,750.00 5,000.00 5,300.00 3,950.00 3,400.00 3,170.00 3,100.00 3,110.00 3,200.00 3,460.00 4,390.00 5,480.00 24 Inventory carrying cost ($) (Q/2 x C x V) Total cost ($)
(Q)
Sensitivity Analysis
Total inventory cost relatively insensitive to order quantities

Actual order quantity: Q Q is a multiple b of the optimal order quantity Q*. For a given b, the quantity ordered is Q = bQ*
b .5 .8 .9 1 1.1 1.2 1.5 2
Increase in cost
25%
2.5%
0.5%
.4%
1.6%
8.9%
25%
25
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
26
Adjustments to EOQ
Adjustments need to be made to include: Volume of transportation costs and Quantity discounts
27
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
28
Cost trade-offs to determine the most Economical Order Quantity with transportation costs included
(A) (B) No. of Order s/Yr (C) Purchase price/order ($) (D) Value of orders/Yr ($) (E) Transportati on cost/order ($) (F) Annual Ord. cost ($) (G) Annual transp. Cost ($) (H) Inv. Carrying cost ($) (I) Total annual cost ($)
Order Qty.
(A) x $8
(B) x ( C)
(B) x $10
(B) x (E)
1/2(C+E)25%
(F+G+H)
300 380 400 800 1200 1600 1800 2000 Given:
54 43 40 20 14 10 9 8
2,400.00 3,040.00 3,200.00 6,400.00 9,600.00 12,800.00 14,400.00 16,000.00
129,600 130,720 128,000 128,000 134,400 128,000 129,600 128,000
300 380 400 780 1,170 1,456 1,638 1,820
540 430 400 200 140 100 90 80
16,200 16,340 16,000 15,600 16,380 14,560 14,742 14,560
338 428 450 898 1346 1782 2005 2228
17,078 17,198 16,850 16,698 17,866 16,442 16,837 16,868
1. Orders for less than 15000 lbs (15000/25=600 cases) have a rate of $ 4.00/cwt, which is = $1 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 per case 3. Orders weighing 40000 or more lbs (1600 cases) have a rate of $ 3.64/cwt, which is = $0.91 per case
29
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
30
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 potential stock-out at the end each order cycle Note: The point at which the order is placed is the primary determinant of future ability to fill demand while waiting for replenishment stock
31
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 a pre-determined minimum level required to satisfy demand during order cycle 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 consolidation savings
32
Forecasting
33
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 of inventories
34
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 distribution centre or a plant ware house)
35
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 dealer cancellations and declining orders Large quantities of obsolete items
36
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 ordercycle time by using advanced order processing systems
37
ABC Analysis
Logic behind ABC Analysis: 20% of firms customers or products account for 80% of the sales (may be 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
38
Sales history for Market Area -1
39
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 weekly May be stocked at regional warehouses Customer service level: Order fill rate of 90% C Items May be least attention May be stocked only at the factory Customer service level: Order fill rate of 85%
Resulting overall Customer service Level of 95%
Note: Though transportation costs for B & C items are greater, inventory reductions are more.
40
Profit Optimization and Service Level

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.
41
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 centers using 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
42
Forecasting
RULES OF FORECASTING The forecast is always wrong. The longer the forecast horizon, the worse the forecast. Aggregate forecasts are more accurate.
43
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
44
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
45
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?
46
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
47
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 and therefore reduces average inventory.
48
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 average demand
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50

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Supply Chain Management

LSM-306 Supply Chain Management

Master of Business Administration (Logistics & Supply Chain Management)

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Why Is Inventory Required?

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Why Is Inventory Required? (2)

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Why Is Inventory Required? (3)

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Why Is Inventory Required? (4)

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Holding the right amount at the right time is difficult!

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

Liz Claibornes higher-than-anticipated excess inventories

IBMs ineffective inventory management

Ciscos declining sales

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Inventory Management-Demand Forecasts

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Supply Chain Factors in Inventory Policy

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

Inventory holding cost, or inventory carrying cost:

Service level requirements

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Typical Inventory positions .

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

RM Inventory FG Inv. At field

Consumer Inventory Re-work/ re-pack of product

Source: Duglas & James

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Toyota calling back cars with sticking pedal

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering

GITAM INSTITUTE OF INTERNATIONAL BUSINESS

Professor P.R.S SARMA M.B.A & Ph.D. - IITD

Effect of Demand Uncertainty

LSM-306 Supply Chain Management 623.925- Logistics Systems Engineering