OPER 312 – Supply Chain Management

Exercise 2: Inventory Management in the Supply Chain

Solutions

Problem 1
Note: They use continuous review.
For continuous review, we need to calculate safety stock with 𝑆𝑆𝑆𝑆𝐿𝐿 = 𝑧𝑧𝐶𝐶𝐶𝐶𝐶𝐶 × 𝜎𝜎𝐿𝐿 ,

using 𝜎𝜎𝐿𝐿 = �𝐿𝐿 × 𝜎𝜎𝐷𝐷2 + 𝑠𝑠𝐿𝐿2 × 𝐷𝐷2 , where 𝑠𝑠𝐿𝐿 = 0 since lead time is given as constant (no variability) for
both transportation modes.

Using Sea Transportation:

a) 𝜎𝜎𝐿𝐿 = �𝐿𝐿 × 𝜎𝜎𝐷𝐷2 + 𝑠𝑠𝐿𝐿2 × 𝐷𝐷2 = √36 × 40002 + 0 = 24,000

𝑆𝑆𝑆𝑆𝐿𝐿 = 𝑧𝑧𝐶𝐶𝐶𝐶𝐶𝐶 × 𝜎𝜎𝐿𝐿 = 𝑧𝑧0.99 × 24000 = 55,920 (where 𝑧𝑧0.99 = 2.33)
𝑅𝑅𝑅𝑅𝑅𝑅 = 𝐷𝐷𝐿𝐿 + 𝑆𝑆𝑆𝑆𝐿𝐿 = (5000𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝) × (36𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑) + 55920 = 235,920

b) Days of safety inventory = 55920/(5000 per day) = 11.18 days

Due to long sea lead time, the resulting safety stock needs to suffice for longer than with air.

c) No pipeline inventory for Motorola, since Motorola takes ownership of orders only on delivery.
Batch Size: Q = 100,000
Cycle inventory = Q/2 = 100000/2 = 50,000
Unit Cost (per phone) with Sea Transportation: C = 100 + 0.5 = 100.5
AHC (for cycle + safety) = (0.2) (100.5) (50000 + 55920) = $2,128,992
APC = (100.5)(5000 per day)(365 days) = $183,412,500
No “per order” cost information given, so we’re ignoring AOC.
TC (AHC + APC) = $185,541,492

d) In this part, we are including the pipeline inventory for Motorola.

Pipeline (In-Transit) Inventory = D×L = (5000 per day)(36 days) = 180,000
AHC (cycle + safety + pipeline) = (0.2) (100.5) (50000 + 55920 + 180000) = $5,746,992
Total Annual Costs (holding + transportation) = $189,159,492

Using Air Transportation:

a) 𝜎𝜎𝐿𝐿 = �𝐿𝐿 × 𝜎𝜎𝐷𝐷2 + 𝑠𝑠𝐿𝐿2 × 𝐷𝐷2 = √4 × 40002 + 0 = 8,000

𝑆𝑆𝑆𝑆𝐿𝐿 = 𝑧𝑧𝐶𝐶𝐶𝐶𝐶𝐶 × 𝜎𝜎𝐿𝐿 = 𝑧𝑧0.99 × 8000 = 18,640 (where 𝑧𝑧0.99 = 2.33)
𝑅𝑅𝑅𝑅𝑅𝑅 = 𝐷𝐷𝐿𝐿 + 𝑆𝑆𝑆𝑆𝐿𝐿 = (5000𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝) × (4𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑) + 18640 = 38,640
b) Days of safety inventory = 18640/(5000 per day) = 3.73 days
Thanks to short air lead time, the necessary safety stock (for the same CSL) is reduced.

c) No pipeline inventory for Motorola, since Motorola takes ownership of orders only on delivery.
Batch size : Q = 5,000
Cycle inventory = Q/2 = 5000/2 = 2,500
Unit Cost (per phone) with Air Transportation: C = 100 + 1.5 = 101.5
AHC (cycle + safety) = (0.2) (101.5) (2500 + 18640) = $429,142
APC = (101.5)(5000 per day)(365 days) = $185,237,500
No “per order” cost information given, so we’re ignoring AOC.
TC (AHC + APC) = $185,666,642
Due to much higher transportation costs, air mode is costlier (despite significant reductions in
inventory holding costs), when inventory ownership is transferred to Motorola at delivery (saving
Motorola from holding costs of pipeline inventory). Therefore, we recommend the sea transportation.

d) In this part, we are including the pipeline inventory for Motorola.

Pipeline (In-Transit) Inventory = D×L = (5000 per day)(4 days) = 20,000
AHC (cycle + safety + pipeline) = (0.2) (101.5) (2500 + 18640 + 20000) = $835,142
TC (AHC + APC) = $186,072,642
When pipeline inventory ownership is with Motorola, sea mode becomes costlier due to long lead
time (time spent in-transit), despite having much lower transportation costs. Therefore, we recommend
the air transportation.

Problem 2
Note: They use periodic review in this case.
For periodic review, we need 𝑆𝑆𝑆𝑆𝑇𝑇+𝐿𝐿 = 𝑧𝑧𝐶𝐶𝐶𝐶𝐶𝐶 × 𝜎𝜎𝑇𝑇+𝐿𝐿 , using 𝜎𝜎𝑇𝑇+𝐿𝐿 = �(𝑇𝑇 + 𝐿𝐿) × 𝜎𝜎𝐷𝐷2 + 𝑠𝑠𝐿𝐿2 × 𝐷𝐷2 ,
where 𝑠𝑠𝐿𝐿 = 0 since lead time is given as constant (no variability) for both transportation modes.

Using Sea Transportation:

a) T = 20 days

𝜎𝜎𝑇𝑇+𝐿𝐿 = �(𝑇𝑇 + 𝐿𝐿) × 𝜎𝜎𝐷𝐷2 + 𝑠𝑠𝐿𝐿2 × 𝐷𝐷2 = �(20 + 36) × 40002 + 0 = 29,933

𝑆𝑆𝑆𝑆𝑇𝑇+𝐿𝐿 = 𝑧𝑧𝐶𝐶𝐶𝐶𝐶𝐶 × 𝜎𝜎𝑇𝑇+𝐿𝐿 = 𝑧𝑧0.99 × 29933 = 69,744 (where 𝑧𝑧0.99 = 2.33)

𝑂𝑂𝑂𝑂𝑂𝑂 = 𝐷𝐷𝑇𝑇+𝐿𝐿 + 𝑆𝑆𝑆𝑆𝑇𝑇+𝐿𝐿 = (5000 𝑝𝑝𝑝𝑝𝑝𝑝 𝑑𝑑𝑑𝑑𝑑𝑑) × (36 + 20 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑) + 69744 = 349,744

b) Days of safety inventory = 69744/(5000 per day) = 13.95 days

Due to long sea lead time, the resulting safety stock needs to suffice for longer than with air.
c) No pipeline inventory for Motorola, since Motorola takes ownership of orders only on delivery.
Average Batch Size: Q = D×T = 100,000
Cycle inventory = Q/2 = 100000/2 = 50,000
Unit Cost (per phone) with Sea Transportation: C = 100 + 0.5 = 100.5
AHC (cycle + safety) = (0.2) (100.5) (50000 + 69744) = $2,406,864
APC = (100.5) (5000 per day) (365 days) = $183,412,500
No “per order” cost information given, so we’re ignoring AOC.
TC (AHC + APC) = $185,819,364

d) In this part, we are including the pipeline inventory for Motorola.

Pipeline (In-Transit) Inventory = D×L = (5000 per day) (36 days) = 180,000
Annual Holding Cost (cycle + safety + pipeline) = (0.2) (100.5) (50000 + 69744 + 180000) = $6,024,864
TC (AHC + APC) = $189,437,364

Using Air Transportation:

a) T = 1 day

𝜎𝜎𝑇𝑇+𝐿𝐿 = �(𝑇𝑇 + 𝐿𝐿) × 𝜎𝜎𝐷𝐷2 + 𝑠𝑠𝐿𝐿2 × 𝐷𝐷2 = �(1 + 4) × 40002 + 0 = 8,944

𝑆𝑆𝑆𝑆𝑇𝑇+𝐿𝐿 = 𝑧𝑧𝐶𝐶𝐶𝐶𝐶𝐶 × 𝜎𝜎𝑇𝑇+𝐿𝐿 = 𝑧𝑧0.99 × 8944 = 20,840 (where 𝑧𝑧0.99 = 2.33)

𝑂𝑂𝑂𝑂𝑂𝑂 = 𝐷𝐷𝑇𝑇+𝐿𝐿 + 𝑆𝑆𝑆𝑆𝑇𝑇+𝐿𝐿 = (5000 𝑝𝑝𝑝𝑝𝑝𝑝 𝑑𝑑𝑑𝑑𝑑𝑑) × (4 + 1 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑) + 20840 = 45,840

b) Days of safety inventory = 20840/(5000 per day) = 4.17 days

Thanks to short air lead time, the necessary safety stock (for the same CSL) is reduced.

c) No pipeline inventory for Motorola, since Motorola takes ownership of orders only on delivery.
Average Batch Size: Q =D×T = 5,000
Cycle inventory = Q/2 = 5000/2 = 2,500
Unit Cost (per phone) with Air Transportation: C = 100 + 1.5 = 101.5
AHC (cycle + safety) = (0.2) (101.5) (2500 + 20840) = $473,805
APC = (101.5) (5000 per day) (365 days) = $185,237,500
No “per order” cost information given, so we’re ignoring AOC.
TC (AHC + APC) = $185,711,305
In the case of periodic review, safety stocks are increased due to longer “protection interval” but it
is increased more drastically for sea transport mode. This results in sea mode being costlier, despite lower
transportation costs, even when ownership of inventory is transferred to Motorola upon delivery.
Therefore, we recommend the air transportation.
d) In this part, we are including the pipeline inventory for Motorola.
Pipeline (In-Transit) Inventory = D×L = (5000)(4) = 20,000
AHC (cycle + safety + pipeline) = (0.2) (101.5) (2500 + 20840 + 20000) = $879,805
TC (AHC + APC) = $186,117,305
When pipeline inventory ownership is with Motorola, sea mode becomes even costlier due to much
longer lead time (time spent in-transit). Therefore, we recommend the air transportation.

Problem 3

Demand per period (weekly) per location, Di = 100

Standard deviation of demand, σD = 80
Ave replenishment lead time, L (weeks) = 4
Standard deviation over L, σL (weeks) = 160
Desired cycle service level, CSL = 0.95
Number of retail outlets 100

Intermediate calculation without pooling with pooling

Mean Weekly Demand, DC = 10000
Standard Deviation of demand, σDC = 800
Mean demand during L, DL = 400 40000
SD of demand during L, σL = 160 1600

Resulting Safety Inventory Level at Each Retail

Outlet
Estimated safety inventory (units) = 263.18 2,631.77
# of days demand = 2.63 0.26

Total Safety Inventory Required

Total Safety Inventory Required 26,317.66 2,631.77

Safety Inventory Saving from going online = 23,685.89

Problem 4

Inputs Bootcut Jeans Wool Coats

Cost per product 20 100
Avg replenishment lead time (weeks) 5 5
Std Dev of lead time (weeks) 1 1
Ordering Cost to Stores 150 150
Annual holding cost rate (per dollar per year) 0.25 0.4
z-value 1.96 1.96
Number of retail outlets 25 25

Retail Channel
Demand Calculations per Store Bootcut Jeans Wool Coats
Mean Weekly Demand 100 15
Standard Deviation of Weekly Demand 8 10
Mean demand during lead time 500 75
Std.Dev. of demand during lead time 101.59 26.93
Cycle Inventory Calculations
EOQ (for each store) 558.57 76.49
Number of orders (per store) 9.31 10.20
Number of orders (total) 232.74 254.95
Cycle Inventory (at each retail store) 279.28 38.24
Cycle Inventory (total) 6982.12 956.07
Safety Inventory Calculations
Safety Stock (at each retail store) 199.11 52.77
Safety Stock (total) 4977.78 1319.37
Annual Ordering Cost 34910.60 38242.65
Annual Holding Cost 59799.51 91017.26

Online Channel
Demand Calculations at Central Warehouse Bootcut Jeans Wool Coats
Mean Weekly Demand 2500 375
Standard Deviation of Weekly Demand 40.00 50.00
Review Period 6 6
Mean demand during T+L 27500 4125
Std. Dev. of demand during T+L 2503.52 410.03
Cycle Inventory Calculations
Number of orders 8.67 8.67
Cycle Inventory 7500.00 1125.00
Safety Stock Calculations
Safety Stock 4906.89 803.66
OUL 32406.89 4928.66
Annual Ordering Cost 1300.00 1300.00
Annual Holding Cost 62034.47 77146.39

Savings due to Centralization (Online Channel)

Additional Unit Transportation Cost 1.00 1.00
Annual Savings in Inventory Holding Cost -2234.96 13870.87
Annual Savings in Ordering Costs 33610.60 36942.65
Annual Additional Transportation Costs 130000.00 19500.00
Net Savings -98624.36 31313.52

Considering all relevant costs, it is evident that moving the Bootcut Jeans to the central warehouse for
online retailing does not make economic sense. However, doing so makes sense for Wool Coats.
Problem 5

Non-pooled (Disaggregated) Option:

Calculations for France (other regions are done similarly, using their own values):

DL = LD = (8)(3,000) = 24,000

σL = Lσ D = 8 × 2,000 = 5,657

ss at France = z CSL × σL = z 0.95 × 5657 = 9,305

where, z 0.95 = 1.645

Pooled (Aggregated) Option:

D = ∑ Di = 3000 + 4000 + 2000 + 2500+ 1000 + 4000 = 16500

C

i =1

σ
C
D
= ∑σ i
2
= 2000 2 + 2200 2 + 1400 2 + 1600 2 + 800 2 + 2400 2 = 4445.22
i =1

DL = L DC = (8)(16500) = 132,000

σL = Lσ DC = 8 (4445.22) = 12,573

SS = z CSL × σL = z 0.95 × 12573 = 20,681

where, z 0.95 = 1.645

Safety inventory savings from aggregation = 48,384 − 20,681= 27,704

A full solution is given in the table below…

Inputs

Weekly demand for Epson printers in Europe

Country Mean Demand Standard Deviation
France 3,000 2,000
Germany 4,000 2,200
Spain 2,000 1,400
Italy 2,500 1,600
Portugal 1,000 800
UK 4,000 2,400

Lead time (weeks) 8

Target cycle service level 0.95

Demand for Epson printers in Europe during Replenishment Lead Time

Mean demand during SD of demand during
Country lead time DL = lead time σL =
France 24,000 5,657
Germany 32,000 6,223
Spain 16,000 3,960
Italy 20,000 4,525
Portugal 8,000 2,263
UK 32,000 6,788
Aggregated 132,000 12,573

Output
Required Safety Inventory for Epson printers in Europe
Country Safety Inventory ss
France 9,305
Germany 10,235
Spain 6,513
Italy 7,444
Portugal 3,722
UK 11,166
Total 48,384

Aggregate at DC 20,681
Savings 27,704
Problem 6
(a)

Non-pooled (Disaggregated) Option:

From the previous problem, we know that the total ss for Europe is 48,384

Holding cost = (200)(0.25)(48,384) = $2,419,200

Pooled (Aggregated) Option:

SS = 20,681

Holding cost = (200)(0.25)(20,681) = $1,034,036

Savings from pooling = $2,419,200 − $1,034,036 = $1,385,164

(b)

If the additional cost of assembly due to pooling is $5/unit, then

the total additional costs = (132000)(52)(5) = $4,290,000

Net Savings = $1,385,164 − $4,290,000 = −$2,904,815

Therefore, it is not economical to centralize to the DC due to additional cost of assembly.

(c)

If the lead time changes to four weeks, we evaluate the safety stocks and associated costs in a similar
manner.

The holding cost from the non-pooled option = (200)(0.25)(34213) = $1,710,650

The holding cost from the pooled option = (200)(0.25)(14623) = $731,150

Savings from pooling = $1,710,650 − $731,150 = $979,500

The savings in this case are even smaller making it uneconomical if the additional cost of assembly is
$5/unit.

We see that a reduction in lead time reduces safety inventory savings due to pooling and makes pooling
less attractive.
Problem 7

Popular Variant Low Volume Variants

Mean demand (weekly) per variant, D i 1000.00 28.00
Standard deviation of (weekly) demand, σD 200.00 20.00
Replenishment lead time, L (weeks) 4.00 4.00
T (weeks ) 4.00 4.00
Desired cycle service level, CSL 0.95 0.95
Number of variants 1.00 9.00
Cost per unit 1000.00 1000.00
Additional Cost per unit due to Component Commonality 25.00 25.00
Inventory Holding Cost 0.25 0.25

a) Without Component Commonality

Standard deviation of demand over T+L (per variant), σ(T+L) 565.69 56.57
Required safety inventory for each variant 930.47 93.05
Required safety inventory (total across the variant) 930.47 837.42

Required safety inventory (total) 1767.89

Annual Holding Cost (total) $ 441,973.12

b) With Complete Component Commonality

Mean demand (weekly) for common components 1252.00
Standard deviation of (weekly) demand 208.81
Standard deviation of demand over T+L, σ(T+L) 590.59
Required safety inventory (total) 971.44
Annual Holding Cost (total) $ 242,859.73
Component cost increase per year $ 1,627,600.00
Net impact of component commonality $ (1,428,486.61)

c) Only Low Volume Variants Use Common Component

Mean demand (weekly) for common components 252.00
Standard deviation of demand per period 60.00
Standard deviation of demand over T+L, σ(T+L) 169.71
Required safety inventory for common components 279.14
Required safety inventory (total, including the popular variant) 1209.61
Annual Holding Cost (total) $ 302,402.66
Component cost increase per year $ 327,600.00
Net impact of component commonality $ (188,029.54)