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OMT 8604 Logistics in Supply Chain Management: Master of Business Administration

The document discusses various factors that contribute to inventory carrying costs, including the cost of capital, unit value of inventory, and average inventory levels. It also examines different approaches to determining optimal order quantities, such as economic order quantity (EOQ) and periodic order quantity, that aim to minimize total relevant costs which include ordering costs, inventory holding costs, and opportunity costs. Lot sizing techniques are discussed for determining order quantities and timing under deterministic time-varying demand conditions.

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66 views42 pages

OMT 8604 Logistics in Supply Chain Management: Master of Business Administration

The document discusses various factors that contribute to inventory carrying costs, including the cost of capital, unit value of inventory, and average inventory levels. It also examines different approaches to determining optimal order quantities, such as economic order quantity (EOQ) and periodic order quantity, that aim to minimize total relevant costs which include ordering costs, inventory holding costs, and opportunity costs. Lot sizing techniques are discussed for determining order quantities and timing under deterministic time-varying demand conditions.

Uploaded by

Mr. Jahir
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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OMT 8604 Logistics in Supply Chain

Management
Master of Business Administration
A Framework for Structuring Drivers
Inventory Costs
• Carrying Cost / Holding Cost:
– Over 65% of most companies do not compute inventory
carrying costs, they use rough estimates
– Leading logistics experts place the cost of carrying
inventory
between 18% per year and 75% per year depending on the
– type of products and business
The standard “rule of thumb” for inventory carrying cost
– is
25% of inventory value on hand
The cost of capital is the leading factor in determining the
percentage of carrying cost
What MakeUp Carryin Cost
g
Inventory Carryin Cost in Summar
g y
Inventory Cost
Carrying Cost =
Ivr
I : is the average
inventory v: is the unit of
carrying one dollar value ($/unit)
inventory for one
ofr: is a carrying charge,
Ordering the cost
cost=
year A is
dollars A: is the cost per replenishment
($/replenishment)
Role of Cycle Inventory in a Supply Chain
• Lot, or batch size: quantity that a supply chain stage either
produces or orders at a given time
• Cycle inventory: average inventory that builds up in the supply
chain because a supply chain stage either produces or purchases
in lots that are larger than those demanded by the customer
• Q = lot or batch size of an order
• d = demand per unit time
• Inventory profile: plot of the inventory level over time
(Fig. 10.1)
• Cycle inventory = Q/2 (depends directly on lot size)
• Average flow time = Avg inventory / Avg flow rate
• Average flow time from cycle inventory = Q/(2d)
Role of Cycle Inventory in a Supply Chain
Q = 1000 units
d = 100 units/day
Cycle inventory = Q/2 = 1000/2 = 500 = Avg inventory level
from cycle inventory
Avg flow time = Q/2d = 1000/(2)(100) = 5 days
• Cycle inventory adds 5 days to the time a unit spends in the
supply chain
• Lower cycle inventory is better because:
• Average flow time is lower
• Working capital requirements are lower
• Lower inventory holding costs
Role of Cycle Inventory in a Supply Chain
• Cycle inventory is held primarily to take advantage of economies of scale in
the supply chain
• Supply chain costs influenced by lot size:
• Material cost = C
• Fixed ordering cost = S
• Holding cost = H = hC (h = cost of holding $1 in inventory for one year)
• Primary role of cycle inventory is to allow different stages to purchase product
in lot sizes that minimize the sum of material, ordering, and holding costs
• Ideally, cycle inventory decisions should consider costs across the entire supply
chain, but in practice, each stage generally makes its own supply chain
decisions – increases total cycle inventory and total costs in the supply chain
Economies of Scale
to Exploit Fixed Costs
Annual demand = D
Number of orders per year = D/Q
Annual material cost = CR
Annual order cost = (D/Q)S
Annual holding cost = (Q/2)H = (Q/2)hC
Total annual cost = TC = CD + (D/Q)S + (Q/2)hC
Figure 10.2 shows variation in different costs for
different lot sizes
Economies of scale

As quantity of production increases from Q to Q2, the average cost of each unit
decreases from C to C1. LRAC is the long run average cost
Economic Order Quantity: EOQ
• Notation
– Q is the order quantity (a.k.a. lot size, or replenishment
quantity)
– D is the demand rate (units/year)
• Decision: How many to order at once?
• Basic EOQ Assumptions:
– Level demand
– Quantities can be fractional
– Unit variable cost do not depend on the quantity ordered
– Replenishments are instantaneous
– Planning horizon is long and model parameters do
not change in time
– Shortages are not allowed
Ordering Cost
Average Holding
Cost
Average Holding
Cost
Total Relevant Cost and
EOQ
TRC=AD/Q+vrQ/2+Dc
EOQ the Economic Order
Quantity
EOQ the Economic Order
Quantity
EOQ
Discussion
EOQ the Economic Order
Quantity

2 2 × 50 × 400
𝐸𝑂𝑄 𝐴𝐷 = × 12 = 326.59 ≅
𝑣𝑟 15 ×
= 327
0.3
𝑇𝑅𝐶 𝐸𝑂𝑄 = 2𝐴𝐷𝑣𝑟 = 2 × 50 × 400 × 12 × 0.3
× 15
=1469.69
EOQ the Economic Order
Quantity

Number of Orders= 400×12


327
=
14.67
Order Size=
400
𝑄
𝐴𝐷
𝑇𝑅𝐶 = 𝑄 + 2 = 12 × 50 + 200 × 15 =1500
𝑣𝑟 × 0.3
TRC(EOQ)=1469.69
Quantity
Discounts
• In practical situation quantity discounts
exists
• Unit variable cost depends on
replenishment Quantity
• We restrict our attention to most common
type of discount structure i.e. all units
discount
Total Relevant
Cost
Case-
1
Acquisition cost
is larger than the
extra carrying
cost.
So we chose
instead of EOQ
Case-
2
Extra Carrying
cost is larger
than the
acquisition cost.
So we choose
EOQ without the
discount
Case-
3
is relatively
low and it may be
attractive to go
for local minimum
which is EOQ
with discount
Algorithm Quantity
Discounts
Quantity Discount
Exercise
Take 15 minutes to solve the following problem:
Determine the best ordering quantity for the following
products:
Product D(u/yr) A($/ord) v($/unit) r(1/yr) d Q_b
A 5000 15 1.5 0.3 0.025 300
B 3000 15 0.5 0.3 0.05 1500
C 8000 15 3 0.3 0.015 3000
Quantity Discount
Exercise
Produc Q_b EOQ EOQd TRC0(EO
Q) TRCd(Qb)
t
A 300 577.3503
584.7053 7759.808 7628.313
B 1500 774.5967
794.7194 1616.19 1561.875
C
3000 516.3978
520.3149 24464.76 25009.75
Product A = Qopt= 584.7
Product B = Qopt = 1500
Product C = Qopt = 516.39
Lot Sizing Under Deterministic Time-Varying Demand

• Previously we assumed a level, deterministic demand rate


• Now we will assume a time varying demand
• We want to determine how much to order and when to order,
such that the costs of ordering and cost of carrying inventory
are minimized.
Common
Heuristics
• Lot for Lot
• Periodic Order
Quantity
• Fixed Order Quantity
• Least Unit Cost
• Part Period Balancing
The
Problem
The table below contains the weekly demand for the next 12
weeks for a given item

Period 1 2 3 4 5 6 7 8 9 10 11 12
Demand 79 82 59 169 61 2 104 45 69 143 68 22

Given the ordering cost, unit value, and opportunity


rate associated with this item,
Determine how much to order and when to order,
such that the costs of ordering, cost of material and
carrying inventory are minimized
The
Problem
Important Assumptions:
1. The given demands will not change during
the planning horizon.
2. Replenishments arrive in the beginning of the
period
3. Carrying costs are not incurred within a period
4. No shortages are allowed
Lot for Lot (L4L)
• Easiest amongst all
• Simply order the exact amount needed for
each time period
• Thus inventory holding cost is zero for lot
for lot

Total cost are = 12X70= 840


Periodic Order
Quantity
Period 1 2 3 4 5 6 7 8 9 10 11 12
Demand 79 82 59 169 61 2 104 45 69 143 68 22
Order Size 161 0 228 0 63 0 149 0 212 0 90 0

Ending 82 0 169 0 2 0 45 0 143 0 22 0


Inventor
y
We can calculate the cost associated with this ordering
solution (A=$70/order, v=$4/unit, and r= 0.2 $/$/week):
(Number of orders)= 6 orders; (Ordering cost)=
6(70)=$420 Inventory carried:
82 units carried one time period
(2-1) 169 units carried one time
period (4-3)
2 units carried one time period (6-5), and so on..
Periodic Order
Quantity
Period 1 2 3 4 5 6 7 8 9 10 11 12
Demand 79 82 59 169 61 2 104 45 69 143 68 22
Order Size 161 0 228 0 63 0 149 0 212 0 90 0

Ending 82 0 169 0 2 0 45 0 143 0 22 0


Inventor
y
Total Inventory Carrying Cost =
σ
[ 𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑐𝑎𝑟𝑟𝑖𝑒𝑑 ∗ 𝑁𝑜. 𝑝𝑒𝑟𝑖𝑜𝑑𝑠 𝑐𝑎𝑟𝑟𝑖𝑒𝑑 ∗ 𝑣𝑟]
=(82+169+2+45+143+22)vr=463(4)(0.2)=$370.40
Total Cost During Planning Horizon = 420+370.40=
$790.40
Least Unit Cost (LUC)
Weeks
Requirem Carryin Order Tota TC
T Lot Size
e nts in g Cost l Per
Inventor Cost Cost Unit
y
1 79 0 0 70 70 79 0.88
2 82 1 65.6 70 135.6 161 0.84
3 59 2 160 70 230 220 1.04
79+82
82X4X.2 = 82X4X.2 = 65.6 +
65.6 59X2X4X0.2
Least Unit Cost (LUC)
Period 1 2 3 4 5 6 7 8 9 10 11 12
Demand 79 82 59 169 61 2 104 45 69 143 68 22
Beginning 0 82 0 169 0 2 0 0 69 0 0 22
Inventory
Order Size 161 0 228 0 63 0 104 114 0 143 90 0
Ending
82 0 169 0 2 0 0 69 0 0 22 0
Inventory
Part Period
Balancing
• We will compare carrying cost with the
holding cost of each period
Weeks Carryin
T Requirements
in g
Inventor Cost
y
1 79 0 0
2 82 1 65.6 <70
3 59 2 160 >70
Forecast Errors
Amount of
inventory
kept on hand
on average to
allow for
uncertainty of
demand and
supply in
short run

11
Thank You

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