Outline

1     

Logistics and Supply Chain Management  Role of Cycle Inventory in a Supply Chain
 E
Economies
i off Scale
S l
 to Exploit Fixed Costs
 to Exploit Quantity Discounts
Managing Economies of Scale  Short-Term Discounting
 Managing Multi-Echelon Cycle Inventory
 in Practice
Chopra and Meindl (2006) Supply Chain Management: Strategy, Planning and Operation. Prentice Hall.
© 2007 Pearson Education

Amir Samimi Civil Engineering Department, Sharif University of Technology

Role of Inventory Role of Cycle Inventory

2     
 3     


 Lot:
Improve Matching of Supply
and Demand  quantity
q y that is pproduces or orders in a stage
g at a ggiven time.
 Cycle inventory:
Improved Forecasting
 Average inventory that is built up because of a mismatch
between production and demand.
Reduce Material Flow Time  Q = lot or batch size of an order
Reduce Waiting Time
 D = demand per unit time

Reduce Buffer Inventory

 Inventory profile
fil

Supply / Demand Seasonal

Economies of Scale Variability Variability

Cycle Inventory Safety Inventory

 Cycle inventory = Q/2
Seasonal Inventory
 Average flow time = Avg inventory / Avg flow rate = Q/(2D)

1
 Role of Cycle Inventory Role of Cycle Inventory
4     
 5     


Q = 1000 units  Cycle inventory is held primarily to

D = 100 units/day  take advantage
g of economies of scale in the supply
pp y chain
Cycle inventory = Q/2 = 1000/2 = 500  Supply chain costs influenced by lot size:
Avg flow time = Q/2D = 1000/(2)(100) = 5 days  Material cost = C
 Fixed ordering cost = S
 Holding cost = H = hC
 Cycle inventory adds 5 days to the time a unit spends in the  h = cost of holding $1 in inventory for one year
supply chain  Primary role of cycle inventory
 to allow different stages to purchase product in lot sizes that
 Lower cycle inventory is better because: minimize the sum of material, ordering, and holding costs
 Average flow time is lower  Ideally, cycle inventory decisions should consider
 Working capital requirements are lower  costs across the entire supply chain,
 Lower inventory holding costs  but each stage generally makes its own supply chain decisions
 this increases total cycle inventory and total costs in the supply chain

Economies of Scale Economies of Scale

6     
 7     


 How do you decide whether to go shopping

 a convenience
i store
t or Sam’s
S ’ Club?
Cl b?
 Lot sizing for a single product (EOQ)
 Aggregating multiple products in a single order
 Lot sizing with multiple products or customers
 Lots are ordered and delivered independently for each
product
 Lots are ordered and delivered jointly for all products
 Lots are ordered and delivered jointly for a subset of
products

2
 Economies of Scale to Exploit Fixed Costs Economic Order Quantity
8     
 9     


 Annual demand = D
D: Annual demand
 A
Annual l material
t i l costt = CD
S: Setup or Order Cost H  hC
h
 Number of orders per year = D/Q C: Cost per unit
Annual order cost = (D/Q)S 2 DS
Q* 
 h: Holding cost per year as a fraction
 Annual holding cost = (Q/2)H = (Q/2)hC of product cost
H: Holding cost per unit per year H
 Total annual cost = TC = CD + ((D/Q)S
Q) + (Q
(Q/2)hC
) Q L
Q: Lott Size
Si
DH
n* 
2S

Example 1 Example 1
10     
 11  
    

 Demand for the Deskpro computer at Best Buy is  Inputs:

1000 units per month.
month  Demand
D d D = 12,000
12 000 computers
t per year
 Best Buy incurs a fixed order placement,  d = 1000 computers/month
transportation, and receiving cost of $4,000 each  Unit cost, C = $500
time an order is placed.  Holding cost fraction, h = 0.2
 Each computer costs Best Buy $500 and the retailer  Fixed cost, S = $4,000/order
has a holding cost of 20 percent
percent.  Outputs:
 Q* = [(2)(12000)(4000)/(0.2)(500)]0.5 = 980
 Evaluate the number of computers that the store  Cycle inventory = Q/2 = 490
manager should order in each replenishment lot.  Flow time = Q/2d = 980/(2)(1000) = 0.49 month
 Reorder interval, T = 0.98 month

3
 Example 1 Example 2
12  
     13  
    

 Annual ordering and holding cost =  If desired lot size = Q* = 200 units, what would S
(12000/980)(4000) + (980/2)(0.2)(500)
(980/2)(0 2)(500) = $97,980
$97 980 have to be?
 D = 12000 units
 C = $500
 Suppose lot size is reduced to Q=200, which would  h = 0.2
reduce flow time:
 Annual ordering and holding cost =  U EOQ equation
Use ti andd solve
l for
f S:
S
(12000/200)(4000) + (200/2)(0.2)(500) = $250,000
 S = [hC(Q*)2]/2D = [(0.2)(500)(200)2]/(2)(12000) =
$166.67
 To reduce optimal lot size by a factor of k, the fixed
order cost must be reduced by a factor of k2

Key Points from EOQ Model Aggregating Multiple Products

14  
     15  
    

 In deciding the optimal lot size, the tradeoff is  Transportation is a significant contributor to cost.
between setup cost and holding cost
cost.  Combine different products from the same
supplier?
 If demand increases by a factor of 4, it is optimal to  same overall fixed cost
increase batch size by a factor of 2.  shared over more than one product
 Cycle inventory should decrease as demand increases.  effective fixed cost is reduced for each product
 lot size for each product can be reduced
 If lot size is to be reduced, one has to reduce fixed
order cost.  A single delivery from multiple suppliers?
 To reduce lot size by a factor of 2, order cost has to be  A single truck delivering to multiple retailers?
reduced by a factor of 4.

4
 Aggregating Multiple Products Example 3
16  
     17  
    

 Aggregating across  Suppose there are 4 computer products:

 products,
d t  Deskpro Litepro,
Deskpro, Litepro Medpro,
Medpro and Heavpro
 retailers,  Demand for each is 1000 units per month
 suppliers  If each product is ordered separately:
 Q* = 980 units for each product
 Total cycle inventory = 4(Q/2) = (4)(980)/2 = 1960 units
 Allows for
 a reduction in lot size  Aggregate orders of all four products:
 Combined Q* = 1960 units
 because fixed ordering and transportation costs are now
spread across multiple products, retailers, or suppliers  For each product: Q* = 1960/4 = 490
 Cycle inventory for each product is reduced to 490/2 = 245
 Total cycle inventory = 1960/2 = 980 units
 Average flow time, inventory holding costs will be reduced

Multiple Products or Customers Example 4

18  
     19  
    

 In practice, the fixed ordering cost is dependent at least in  Best Buy sells three models of computers:
part on the variety
p y associated with an order of multiple
p
models  th Litepro,
the Lit th Medpro,
the M d and
d the
th Heavypro.
H
 A portion of the cost is related to transportation  Annual demands:
(independent of variety)  OL = 12000, OM = 1200, and OH = 120
 A portion of the cost is related to loading and receiving
(not independent of variety)  Costs:
 Three scenarios:  Each model costs Best Buy $500
 Lots are ordered and delivered independently for each  Fixed transportation cost: $4000
product  Product specific order cost: $1000
 Lots are ordered and delivered jointly for all three models  Best Buy incurs a holding cost of 20 percent.
 Lots are ordered and delivered jointly for a selected
subset of models

5
 No Aggregation Delivery Options
20  
     21  
  
  

 No Aggregation
 Each product ordered separately

 Complete Aggregation:
 All products delivered on each truck

Total cost = $155,140  Tailored Aggregation

 Selected subsets of products on each truck

Order All Products Jointly Order All Products Jointly

22  
  
   23  
  
  

 S* = S + sL + sM + sH = 4000+1000+1000+1000 =
$7000

DH
n* 
2S

 .

 QL = DL/n* = 12000/9.75 = 1230

 QM = DM/n* = 1200/9.75 = 123
Annual order cost = 9.75 × $7,000 = $68,250
 QH = DH/n* = 120/9.75 = 12.3
Annual total cost = $136,528

6
 Tailored Aggregation Tailored Aggregation
24  
  
   25  
  
  

 The procedure we discuss  Step 2

 Does nott provide
D id the
th optimal
ti l solution.
l ti  Order
O d ffrequency ffor all
ll other
th products
d t
 It yields an ordering policy whose cost is close to optimal.  only the product-specific fixed cost

 Step 1
 Identify the most frequently ordered.
 Assuming each product is ordered independently.
 Evaluate the frequency of product i relative to the most
frequently ordered product

Tailored Aggregation Example

26  
  
   27  
  
  

 Step 3  Consider the Best Buy data

 H i th
Having the ordering
d i frequency
f off eachh product,
d t
recalculate the ordering frequency of the most
frequently ordered product.
 Step 1

 Step 4
 For each product, evaluate an order frequency

7
 Example Lessons from Aggregation
28  
  
   29  
  
  

 Step 2  Aggregation allows firm to

 l
lower lot
l t size
i without
ith t increasing
i i costt

 Complete aggregation is effective if

 product specific fixed cost is a small fraction of joint
fixed cost

 Step 3
 Tailored aggregation is effective if
 product specific fixed cost is a large fraction of joint fixed
 Step 4 cost

Economies of Scale: Quantity Discounts Quantity Discounts

30  
  
   31  
  
 
 

 All-unit quantity discounts  Lot size based

 M i l unit
Marginal it quantity
tit discounts
di t  All units
it
 Why quantity discounts?  Marginal unit
 Coordination in the supply chain  Volume based
 Price discrimination to maximize supplier profits
 How should buyer react?
 What are appropriate discounting schemes?

8
 All-Unit Quantity Discounts All-Unit Quantity Discount Procedure
32  
  
 
  33  
  
 
 

 Pricing schedule has specified quantity break points  Step 1

 Calculate EOQ Q for the lowest pprice. If it is feasible, then stop.
p
 q0, q1, …, qr, where
h q0 = 0  This is the optimal lot size.
 Step 2
 If the EOQ is not feasible, calculate the TC for this price and
the smallest quantity for that price.
 Step 3
 Calculate EOQ for next lowest price.
 If it is feasible
feasible, stop and calculate TC for that price.
price
 Step 4
 Compare TC form Steps 2 and 3. Choose the cheapest.
 Step 5
 The objective is  If EOQ in Step 3 is not feasible, repeat Steps 2, 3, and 4 until a
 to decide on a lot size that will minimize total costs feasible EOQ is found.

All-Unit Quantity Discounts: Example All-Unit Quantity Discount: Example

34  
  
 
  35  
  
 
 

Cost/Unit Total Material Cost

Order quantity Unit Price
0 5000
0-5000 $3 00
$3.00
5001-10000 $2.96
$3
$2.96 Over 10000 $2.92
$2.92

q0 = 0, q1 = 5000, q2 = 10000
C0 = $3.00, C1 = $2.96, C2 = $2.92
5,000 10,000 5,000 10,000 D = 120000 units/year,
S = $100/lot,
Order Quantity Order Quantity h = 0.2

9
 All-Unit Quantity Discount: Example All-Unit Quantity Discount: Example
36  
  
 
  37  
  
 
 

 Step 1  Step 2
 Calculate Q2*  Calculate Q1*
 = Sqrt[(2DS)/hC2] = Sqrt[(2)(120000)(100)/(0.2)(2.92)] = 6410  = Sqrt[(2DS)/hC1] =Sqrt[(2)(120000)(100)/(0.2)(2.96)] = 6367
 Not feasible (6410 < 10001)
 Calculate TC2  Feasible (5000<6367<10000)  Stop
 using C2 = $2.92 and q2 = 10001
 = (120000/10001)(100)+(10001/2)(0.2)(2.92)+(120000)(2.92)=
$354,520
 Calculate TC1
 = (120000/6367)(100)+(6367/2)(0.2)(2.96)+(120000)(2.96)=
(120000/6367)(100)+(6367/2)(0 2)(2 96)+(120000)(2 96)=
$358,969

 TC2 < TC1

 The optimal order quantity Q* is q2 = 10001

All-Unit Quantity Discounts Why Quantity Discounts?

38  
  
 
  39  
  
 
 

 Suppose fixed order cost were reduced to $4  Coordination in the supply chain
 Without discount,
discount QQ* would be reduced to 1265 units  Commodity
C dit products
d t
 With discount, optimal lot size would still be 10001 units  Products with demand curve
 2-part tariffs
 What is the effect of such a discount schedule?  Volume discounts
 Retailers are encouraged to increase the size of their
orders
 Average inventory in the supply chain is increased
 Average flow time is increased
 Is an all-unit quantity discount an advantage in the supply
chain?

10
 Coordination for Commodity Products Coordination for Commodity Products
40  
  
 
  41  
  
 
 


 D = 120,000 bottles/year  What can the supplier do to decrease supply chain

 SRetailer = $100,
$100 hR = 0.2,
0 2 CR = $3 costs?
 SSupplier = $250, hS = 0.2, CS = $2  Coordinated lot size: 9,165; Retailer cost = $4,059;
Supplier cost = $5,106; Supply chain cost = $9,165
 Effective pricing schemes
 Retailer’s optimal lot size = 6,324 bottles  All-unit quantity discount
 Retailer cost = $3,795
$ ,  $ for lots below 9,165
$3 ,
 $2.99 for lots of 9,165 or more
 Supplier cost = $6,009
 Pass some fixed cost to retailer (enough that he raises
 Supply chain cost = $9,804 order size from 6,324 to 9,165)

Discounts: Firm Has Market Power Two-Part Tariffs and Volume Discounts
42  
  
 
 
 43  
  
 
 


 No inventory related costs  Design a two-part tariff that achieves the

 D
Demand d curve coordinated solution
360,000 - 60,000p  Design a volume discount scheme that achieves the
 What are the optimal prices and profits in the coordinated solution
following situations?  Impact of inventory costs
 The two stages coordinate the pricing decision  Pass on some fixed costs with above pricing
 Price = $4, Profit = $240,000, Demand = 120,000
 The two stages make the pricing decision independently
 Price = $5, Profit = $180,000, Demand = 60,000

11
 Lessons from Discounting Schemes Short-Term Discounting
44  
  
 
 
 45  
  
 
 


 Lot size based discounts  Trade promotions are price discounts for a limited
 iincrease lot
l t size
i andd cycle
l inventory
i t period of time.
time
 are justified to achieve coordination for commodity
products  Key goals from a manufacturer’s perspective:
 Volume based discounts  Induce retailers to use price discounts, displays,
advertising to increase sales.
 with some fixed cost passed on to retailer
 Shift inventory to the retailer and customer
 more effective in general
 Defend a brand against competition
 better over rolling horizon

Short-Term Discounting Short Term Discounting

46  
  
 
 
 47  
  
 
 


 What is the impact on

*
 behavior of retailer? Assuming CQ
 d dD
 performance of supply chain?  Discount is offered once Q = +
(C - d )h C - d
 Customer demand is unchanged.

 Retailer has two primary options:

 Pass through some of the promotion to customers. Forward buy = Qd - Q*

 Purchase in ggreater quantity

q y duringg promotion
p period
p to Q*: Normal order quantity
take advantage of temporary price reduction.
C: Normal unit cost
d: Short term discount
D: Annual demand
h: Cost of holding $1 per year
Qd: Short term order quantity

12
 Example: Forward Buying Homework 6
48  
  
 
 
 49  
  
 
 


 Normal order size, Q* = 6,324 bottles Chapter 10

 N
Normall cost,
t C = $3 per bbottle
ttl  E
Exercises:
i
 Discount per tube, d = $0.15  4
 5
 Annual demand, D = 120,000
 6
 Holding cost, h = 0.2

 Qd =?
 Forward buy =?

13