Gestión del Upstream/

Logística de Entrada
(Inventario y Abastecimiento)

Mauricio Garcia S.G, MBA

114
 1. Introduction to Inventory Management

2. Total Relevant Cost

3. EOQ
Agenda 4. Stochastic Demand
Part I – Inventory 5. Base Stock Policy

6. Continuous Review Policies

7. Periodic Review Policies

115
 1. Introduction to Inventory Management

2. Total Relevant Cost

3. EOQ
Agenda 4. Stochastic Demand
Part I – Inventory 5. Base Stock Policy

6. Continuous Review Policies

7. Periodic Review Policies

116
Why hold inventory? Cover process time

Allow for uncoupling of processes

Anticipation / Speculation

Minimize control costs

Buffer against uncertainties

• Demand

• Supply

• Delivery

• Manufacturing/Processing

117
 Three Levels of Inventory
Decisions Strategic
SC Decision

3
Strategic:
- What are the potential alternatives to inventory?
- How should the product be designed?
Operational /
Tactical: Tactical / Replenishment
- What items should be carried as inventory?
Deployment
- In what form should they be maintained?
Decision
Operational:
- How often should inventory status be determined?
- When should a replenishment decision be made?
- How large should the replenishment be?

118
 Classification of Inventory

Funcional Roles Financial/ Accounting Categories

RM WIP
FG

119
ABC Inventory

Exercise in Class

120
 1. Introduction to Inventory Management

2. Total Relevant Cost

3. EOQ
Agenda 4. Stochastic Demand
Part I – Inventory 5. Base Stock Policy

6. Continuous Review Policies

7. Periodic Review Policies

121
Total Relevant Cost TRC
What makes a cost relevant?

Four Standard Cost Components

• Purchase(Unit Value) Cost C

• Ordering (Set Up) Cost Ct

• Holding(Carrying)Cost Ce =Ch

• Shortage Cost Cs

122
Purchase (Unit Value) Costs c
Units?

• $ / Unit

What does it contain?

• Total landed cost for acquiring product

How do we determine this number?

• Purchase price vs. manufacturing cost

When is it relevant?

• When purchase price differs with respect to quantity or timing of order

123
Holding (Carrying) Costs ch=ce
Units?
• $/unit-time where h=$/$inventory/time

What does it contain?

• Costs required to hold inventory
• Storage - $/sf – warehouse space
• Service costs-$/$inv–insurance and taxes
• Risk costs-$/item–lost, stolen(shrinkage), damaged, obsolete
• Capital costs - $/$inv – cost of capital, hurdle rate

How do we determine this number?

• Usually set by management
• Worth seeing if any of the secondary aspects dominate

When is it relevant?
• Whenever inventory is being held for any period of time

124
Costo de Venta Perdida cs
Units?
• $/unit or $/unit/time or $/order or . . . .

What does it contain?

• Cost of not having an item in stock
• Back order–customer will wait for item
• Lost Sales–customer goes elsewhere (fill or kill)
• Lost Customer Sales–customer goes away forever
• Disruption Costs–holds up production line

How do we determine this number?

• Engineer the cost – determine specific values
• Implicitly assume the cost by establishing a set service level

When is it relevant?
• Whenever there is uncertainty in demand, replenishment time, etc.

125
 1. Introduction to Inventory Management

2. Total Relevant Cost

3. IRM EOQ
Agenda 4. IRM Stochastic Demand
Part I – Inventory 5. IRM Base Stock Policy

6. IRM Continuous Review Policies

7. IRM Periodic Review Policies

126
Inventory Replenishment Model
Objective.
• Find an optimal policy for managing inventory

Policy consist of:

• How much to order (Q)
• When to order:
• Time based – every T time units
• Quantity based – when inventory is a certain level
• Combination

127
Replenishment Model Assumptions
Demand. Capacity. Planning Horizon
• Constant vs Variable • Unlimited • Single period
• Know vs Random • Limited / Constrained • Finite period
• Continuous vs Discrete • Infinite
Discounts
Lead time • None Number of Items
• Instantaneous • All Units vs Incremental vs One Time • One vs Many
• Constant vs Variable • Deterministic vs Stochastic
• Deterministic vs Stochastic • Internally Replenished Form of Product
• Internally Replenished • Single Stage
Excess Demand • Multi Stage
Dependence of Items • None
• Independent • All orders are backordered
• Correlated • Lost Orders
• Indentured • Substitution

Review Time Perishability

• Continuous vs Periodic • None
• Uniform with time
Number Locations • Non-linear with time
• One vs Multi vs Multi-Echelon

128
Replenishment Model Assumptions
Demand. Capacity. Planning Horizon
• Constant vs Variable • Unlimited • Single period
• Know vs Random • Limited / Constrained • Finite period
• Continuous vs Discrete • Infinite
Discounts
Lead time • None Number of Items
• Instantaneous • All Units vs Incremental vs One Time • One vs Many
• Constant vs Variable • Deterministic vs Stochastic
• Deterministic vs Stochastic • Internally Replenished Form of Product
• Internally Replenished • Single Stage
Excess Demand • Multi Stage
Dependence of Items • None
• Independent • All orders are backordered
• Correlated • Lost Orders
• Indentured • Substitution

Review Time Perishability

• Continuous vs Periodic • None
• Uniform with time
Number Locations • Non-linear with time
• One vs Multi vs Multi-Echelon

129
Notation
D = Average Demand (Units/time)
c = Variable (Purchase) Cost ($/unit)
ct = Fixed Ordering Cost ($/order)
h = Carrying or Holding Charge ($/inventory $/time)
ce=ch Excess Holding Cost ($/unit/time)
Q = replenishment Order Quantity (units/order)
T = Order Cycle Time (time/order)
N = 1/T = Order per Time (order/time)

TRC (Q) = Total Relevant Cost

TC(Q) = Total Cost ($/time)

130
Inventory Charts
Model Assumptions (EOQ)
• Demand is uniform and deterministic
• Lead Time is instantaneous (0)
• Total amount ordered is received

Area of a triangle = ½ b*h = ½ 1 Q

131
Total Relevant Cost TRC

Which cost are relevant to the order quantity decision?

!"#= ct*(D/Q) + ch*(Q/2)

132
Building Intuition
Example:
• What is the optimal order quantity for a product with:
• Demand = 2000 units/year
• Cost of placing an order = 500 $/order
• Cost of product = 50 $/unit
• Holding cost = 25% of unit cost per year
• Selling price of product = 75 $/unit

133
Formulas

Df = Forecasted Demand
Qf* = EOQ using Forecast Demand
Da= Actual Demand (what really occurred)
Qa*=EOQ calculated with Actual Demand
134
Building Intuition
Example:
• What is the optimal order quantity for a product with:
• Demand = 2000 units/year
• Cost of placing an order = 500 $/order
• Cost of product = 50 $/unit
• Holding cost = 25% of unit cost per year
• Selling price of product = 75 $/unit
• Would you rather order Q>Q* or Q<Q*?
• Use Q 800,600,400,200,20

135
Building Intuition
Example:
• What is the optimal order quantity for a product with:
• Demand = 2000 units/year
• Cost of placing an order = 500 $/order
• Cost of product = 50 $/unit
• Holding cost = 25% of unit cost per year
• Selling price of product = 75 $/unit
• Use D 200, 1000, 1500, 1800, 2000, 3000, 4000, 20.000

136
Building Intuition
Example:
• What is the optimal order quantity for a product with:
• Demand = 2000 units/year
• Cost of placing an order = 500 $/order
• Cost of product = 50 $/unit
• Holding cost = 25% of unit cost per year
• Selling price of product = 75 $/unit
• What if I order weekly? Monthly ? Other?

137
Building Intuition
Example:
• What is the optimal order quantity for a product with:
• Demand = 2000 units/year
• Cost of placing an order = 500 $/order
• Cost of product = 50 $/unit
• Holding cost = 25% of unit cost per year
• Selling price of product = 75 $/unit
• Power of two Policies
• Use weekly time

138
Replenishment Model Assumptions - Extensions
Demand. Capacity. Planning Horizon
• Constant vs Variable • Unlimited • Single period
• Know vs Random • Limited / Constrained • Finite period
• Continuous vs Discrete • Infinite
Discounts
Lead time • None Number of Items
• Instantaneous • All Units vs Incremental vs One Time • One vs Many
• Constant vs Variable • Deterministic vs Stochastic
• Deterministic vs Stochastic • Internally Replenished Form of Product
• Internally Replenished • Single Stage
Excess Demand • Multi Stage
Dependence of Items • None
• Independent • All orders are backordered
• Correlated • Lost Orders
• Indentured • Substitution

Review Time Perishability

• Continuous vs Periodic • None
• Uniform with time
Number Locations • Non-linear with time
• One vs Multi vs Multi-Echelon

139
Leadtime > 0
What is the average amount
of pipeline inventory?

Cycle length = T*
L Pipeline level changes over
replenishment cycle
Pipeline = Q* which happens L/T* of the
cycle
Not in transit = 0 which happens (1-L/T*)
of the cycle
Average pipeline Inventory
IOO /Pipeline
Inventory = Q*(L/T*)+0*(1-L/T*)=Q*(DL/Q*)=DL
Position Average inventory in the system?
IOH
Cicle Stock + Pipeline = Q/2+DL

140
Total Relevant Cost TRC / L>0

Which cost are relevant to the order quantity decision?

!"#= ct*(D/Q) + ch*(Q/2)

What is my new optimal policy? DL

Order Q* units when IP = DL
L
Order Q* units every T* time periods
T
141
Discounts
All Units Discount
• Discount applies to all units purchased if total
amount exceeds the break point quantity

Incremental Discount
• Discount applies only to the quantity purchased that
exceeds the break point quantity

One Time Only Discount

• A one time only discount applies to all units your
order right now (No quantity minimum or limit)

142
Discounts All Units

143
Incremental Discount

144
EOQ with Planned Back Orders
D= Average Demand (units/time)
c= Variable (Purchase) Cost ($/unit)
ct= Fixed Ordering cost ($/order)
h = Carrying or Holding Charge ($/inventory $/time) Q-b
ce = c*h = Excess Holding Cost ($/unit/time)
Ce
cs = Shortage Cost ($/unit/time) T1 T2
Q = Replenishment Order Quantity (units/order) Cs
T = Order Cycle Time (Time/order) b
N = 1/T = Orders per Time (Order/Time)

TRC(Q) = Total Relevant Cost ($/Time)

TC(Q) = Total Cost ($/time)
From Similar Triangles

145
 1. Introduction to Inventory Management

2. Total Relevant Cost

3. IRM EOQ
Agenda 4. IRM Stochastic Demand
Part I – Inventory 5. IRM Base Stock Policy

6. IRM Continuous Review Policies

7. IRM Periodic Review Policies

146
 Inventory Charts
Deterministic Demand Stochastic Demand
D is D is random variable.
constant We need to Know the
and Know shape of the distribution

Fixed T with changing Q

Q* and T*
are fixed

LeadTime
maybe constant
or variable

Potential Excess
Demand (SO)
Need to determine
Safety Stock
147
Three Question we will want to answer
Assuming my demand follows some specific distribution…
1. How much inventory on hand IOH do I need so P(SO)<= some target service level?
2. If I have a certain amount of inventory on hand, X, what is my P(SO)?
3. Given a target service level or IOH how many units do I expect to sell or be short?

148
Replenishment Model Assumptions
Demand. Capacity. Planning Horizon
• Constant vs Variable • Unlimited • Single period
• Know vs Random • Limited / Constrained • Finite period
• Continuous vs Discrete • Infinite
Discounts
Lead time • None Number of Items
• Instantaneous • All Units vs Incremental vs One Time • One vs Many
• Constant vs Variable • Deterministic vs Stochastic
• Deterministic vs Stochastic • Internally Replenished Form of Product
• Internally Replenished • Single Stage
Excess Demand • Multi Stage
Dependence of Items • None
• Independent • All orders are backordered
• Correlated • Lost Orders
• Indentured • Substitution

Review Time Perishability

• Continuous vs Periodic • None
• Uniform with time
Number Locations • Non-linear with time
• One vs Multi vs Multi-Echelon

149
Common Probability Distributions for
Inventory
Empirical: Historical Demand
Theoretical:
• Discrete: Uniform & Poisson
• Continuous: Uniform, Normal & Triangle

Three Critical Questions to Answer

1. What is the probability of Stoking Out for a given an inventory level?
2. How much inventory is required to meet a target service level?
3. What are the expected values of units sold and units short for a target inventory or service level?

150
Common Probability Distributions for
Inventory
RC are some of the most profitable products that a supermarket
sells. They need to be prepared ahead of time and must be kept
warm throught the day. They can only be sold the day that they
are roasted. We know the demand requested each day because
customers have to ask for the chickens from the deli counter.

1. How many chickens should you produce each day to make

sure you meet 90% of the demand, that is, P[SO]=10%

2. What is the probability of SO each day if you make X

chickens?

3. How many chickens do you expect to sell (and be short)

each day?

151
Rotisserie chickens empirical
distribution

Step 1. Create a Probability chart and Cumulative Probability

Step 2. Answer the mean and deviation
Step 3. Answer the three questions. 8 chickens are roasted
1. P[SO] <=10%. How many Chickens? / P[SO] 8 Chickens Roast / Expected

152
Empirical vs theoretical distribution

Using empirical demand distribution

• Tempting since you probably have the exact historical data,

• Requires great deal of data for each SKU
• Assume the next year will follows this year exactly

Theoretical Distribution

• Requires less data

• Robust demand structure
• Inventory planning requires theoretical distributions

153
Rotisserie chickens Discrete uniform
distr.

Identify the minimum and maximum

If we have an uniforms distribution what is the probability?

154
2024
Rotisserie chickens Discrete uniform
distr.

1. How many chickens are needed for P[SO] <=10%?

2. What is P[SO] if 8 chickens are roasted?
3. What is the E[US] and E[Units sold] if 8 Chickens are roasted?

155
Rotisserie chickens Poisson Distr.

156
Rotisserie chickens Poisson Distr.

How many chickens are needed for P[SO]<=10%?

What is P[SO] if 3 Chickens are roasted?
What is the E[Units Solds], E[US] if 3 chickens are
roasted?

157
Rotisserie chickens Continuous
Uniform

158
Rotisserie chickens Continuous
Uniform

1. How many chickens are needed for P[SO] <=10%?

2. What is the P[SO] if 75 chickens are roasted?

159
Rotisserie chickens Normal Dist.

160
Rotisserie chickens Normal Dist.

161
Rotisserie chickens Normal Dist.
1. How many chickens are needed for P[SO]<=10%
2. What is the P[SO] if 99 chickens are roasted?
3. E[Units Sold] and E[Units Short] if 99 chickens are roasted?

NORM.INV(Prob,Mean, Sigma)
NORM.DIST(X,Mean, Sigma, 1) = Cycle Service Level
1-CSL= P[SO]
E(Units Short) Sigma*G(k)
K=(X-U)/ Sigma

162
Rotisserie chickens Triangle Dist.

163
Rotisserie chickens Triangle Dist.

164
 1. Introduction to Inventory Management

2. Total Relevant Cost

3. IRM EOQ
Agenda 4. IRM Stochastic Demand
Part I – Inventory 5. IRM Base Stock Policy

6. IRM Continuous Review Policies

7. IRM Periodic Review Policies

165
Replenishment Model Assumptions
Demand. Capacity. Planning Horizon
• Constant vs Variable • Unlimited • Single period
• Know vs Random • Limited / Constrained • Finite period
• Continuous vs Discrete • Infinite
Discounts
Lead time • None Number of Items
• Instantaneous • All Units vs Incremental vs One Time • One vs Many
• Constant vs Variable • Deterministic vs Stochastic
• Deterministic vs Stochastic • Internally Replenished Form of Product
• Internally Replenished • Single Stage
Excess Demand • Multi Stage
Dependence of Items • None
• Independent • All orders are backordered
• Correlated • Lost Orders
• Indentured • Substitution

Review Time Perishability

• Continuous vs Periodic • None
• Uniform with time
Number Locations • Non-linear with time
• One vs Multi vs Multi-Echelon

166
Base Stock Policy

• One for One Order Policy

• IP stays constant at Base Stock
• When is this used?
• How do we set the Base Stock (S*)?
• Cover potential demand over lead time for desired
Lead Time level of service (LOS)
• LOS here is defined as the probability of not
stocking out = P(Udl <= S*)

IOH

167
Base Stock Policy
Set the Base Stock Policy for an item:
How do I set the level of Service (LOS)?
• Daily demand N (100,15)
• Management decision
• Lead Time is 2 days
• Using Critical Ratio
• Excess cost is 5 $ per unit per day
• Shortage cost is $25 per unit per day

• LOS is the probability that no stock outs will occur during

the lead time replenishment period

• Base Stock, S*, is set to this amount:

168
 1. Introduction to Inventory Management

2. Total Relevant Cost

3. IRM EOQ
Agenda 4. IRM Stochastic Demand
Part I – Inventory 5. IRM Base Stock Policy

6. IRM Continuous Review Policies

7. IRM Periodic Review Policies

169
Continuous Review Policies
Order Point, Order Quantity (s,Q)
Policy: Order Q if IP<=s
s+Q
Two bin system (Cycle Stock, Safety
Stock
Q Q
CS

SS
L

170
Continuous Review Policies
Order Point, Order Quantity (s,S)
Policy: Order (S-IP) if IP<=s
S
Min-Max system

171
Continuous Review Policies
Finding Q
Determines the level of Cycle Stock
Usually from EOQ
Finding s
Based on expected demand over lead time (forecast amount)
Added in safety or buffer stock for variability

Reorder point Safety Stock, K SS Factor / Sigmadl RMSE

Forecast mean demand over leadtime

172
What cost and service objetives?
Common Safety factor approach

• Simple, widely used method

• Apply a common metric to aggregate items

Customer service Approach

• Establish constrain on customer service

• Definitions in practice are fuzzy
• Minimize cost with respect to customer service constrains

Cost Minimization Approach

• Requieres costing of shortages

• Find tradeoff between relevant cost

173
Service and Cost metrics
Performance metrices

• Cycle Service Level CSL

• Item Fill Rate IFR

Stockout Cost Metrics

• Cost per Stockout Event CSOE

• Cost per item Short CIS

174
Cycle Service Metric CSL
Probability of no stockout per replenishment cycle

Equal to one minus the probability of stocking out

X is the demand during lead time

= 1- P[SO] = 1-P[X>s] = P[X<=s]

175
Cycle Service Metric CSL
You are managing the inventory for a production part with annual
demand N (62.000, 8.000). The cost of the item, c, is 100 USD
and the holding charge is 15% per year. You have determined
that the EOQ is 5.200 units, Lead Time is 2 weeks

Assuming CSL 95%, find the appropriate (s,Q) policy

176
Item fill rate (IFR)
You are managing the inventory for a production part with
Fraction of customer demand met routinely from annual demand N (62.000, 8.000). The cost of the item,
IOH c, is 100 USD and the holding charge is 15% per year.
You have determined that the EOQ is 5.200 units, Lead
This is equal to one minus the fraction we Time is 2 weeks
expect to be short
Assuming IFR 99%, find the appropriate (s,Q) policy
Logic Rule:

• We order Q each cycle

• The fraction we are short = E(US)/Q
• Therefore, IFR =. 1 – E(US)/Q
• Assuming Normal E(US)= sigmadl G(k)
• Calculate the desired G(k)
• Find appropriate k

177
Cost per Stockout Event CSOE
Consider total costs

• Purchase Price – No change

• Order Cost – No change from EOQ

• Holding Cost - add in Safety Stock

What cost are relevant?
• StockOut Cost product of: How do I solve for k?

• Cost per stockout event (CSOE), B1

• Number of replenishment cycles
• Probability of a stockout per cycle

178
Cost per Stockout Event CSOE
Take First Order Conditions wrt k…. Decision Rule for B1 Cost

Recall that for Normal Distribution:

Which give us:

Otherwise, set k as low as management allows

Questions
Solving for k.. -Why is the first condition there?
-What K would management allow?

179
Cost per Stockout Event CSOE
You are managing the inventory for a production part with annual
demand N (62.000, 8.000). The cost of the item, c, is 100 USD and
the holding charge is 15% per year. You have determined that the
EOQ is 5.200 units, Lead Time is 2 weeks

Assuming CSOE = B1=50.000 USD per event since it shuts the

production line down , find an appropriate (s,Q) policy.

180
Cost per item Short (CIS)
Consider total cost Decision Rule for B1 Cost
• Purchase Price – No change
• Order Cost – No change from EOQ
• Holding Cost - add in Safety Stock
• StockOut Cost product of:
Ø Cs Cost per item stocked out cs Otherwise, set k as low as management allows
Ø Estimated number of units short
Ø Number of replenishment cycles Questions
-Why is the first condition there?
-What K would management allow?

What cost are relevant?

How do I solve for k?
181
Cost per Stockout Event CSOE
You are managing the inventory for a production part with annual
demand N (62.000, 8.000). The cost of the item, c, is 100 USD and
the holding charge is 15% per year. You have determined that the
EOQ is 5.200 units, Lead Time is 2 weeks

Assuming CSI = Cs=45 USD per unit-year, find an appropriate

(s,Q) policy.

182
 1. Introduction to Inventory Management

2. Total Relevant Cost

3. IRM EOQ
Agenda 4. IRM Stochastic Demand
Part I – Inventory 5. IRM Base Stock Policy

6. IRM Continuous Review Policies

7. IRM Periodic Review Policies

183
Replenishment Model Assumptions
Demand. Capacity. Planning Horizon
• Constant vs Variable • Unlimited • Single period
• Know vs Random • Limited / Constrained • Finite period
• Continuous vs Discrete • Infinite
Discounts
Lead time • None Number of Items
• Instantaneous • All Units vs Incremental vs One Time • One vs Many
• Constant vs Variable • Deterministic vs Stochastic
• Deterministic vs Stochastic • Internally Replenished Form of Product
• Internally Replenished • Single Stage
Excess Demand • Multi Stage
Dependence of Items • None
• Independent • All orders are backordered
• Correlated • Lost Orders
• Indentured • Substitution

Review Time Perishability

• Continuous vs Periodic • None
• Uniform with time
Number Locations • Non-linear with time
• One vs Multi vs Multi-Echelon

184
Periodic review policy (R,S) – Time Based
Order up to level (R,S) -Hybrid (R,s,S) System
• Policy: Order Every R time periods, Order
• Policy: Order S – IP every R time periods S-IP if IP <= s, if IP>s then not order
• Replenishment cycle system
• General case for many policies

S
S

185
Periodic review policy (R,S) – Time Based

-Differences from Continuous Review Policy (s,Q)

-How much to order? DR
-How long should safety stock cover? L+R

186
Periodic Review Policies (R,S)
-Convenient transformation of (s,Q) to (R,S)
-(s,Q) = Continuous, order when IP<=s
-(R,S) = Periodic , order up to S every R time periods
-Always for the use of all previous (s,Q) decision rules
-S for continuous system becomes S for periodic system
-Q for continuous system becomes D*R for periodic system
-L for continuous system becomes R+L for periodic system
Approach
Make transformations
Solve for (s,Q) using transformations
Determine final policy, so that
S = XDL+R +. KsigmaDl+R

187
Periodic Review Policies (R,S)
ShopCo is a North America based large store format retailer of home improvement products
with >2000 stores. Each ShopCo store generally operates independently: ordering and
reciving product directly from its suppliers.
One Supplier (Hurricane Drill) sells a portfolio of electric drills that, on average, cost
ShopCO 75 USD each. Each store uses periodic review policies to order directly from
Hurricane and uses an annual holding charge of 15%. Assume 52 week year.

-Problem
-Fin R,S ordering policy for Hurricane drills for store 1301 given:
-Forecasted annual demand of Hurricane Drills N (3400, 400)
-Lead Time 1 week
-Review policy 4 weeks
-CSL desired 95%
-Hurricane has a minimum order quantity MOQ of 240 drills
-Orders need to be in multiples of 12 drills to fit on pallets
-What is the expected annual cost of cycle and safety stock?

188
Periodic Review Policies (R,S)
New Mixing Center Strategy

ShopCo has decided to deploy a fulfillment strategy where each store orders from it
Regional Distribution Center RDC instead of directly to the supplier

Each ShopCo RDC then consolidate orders from its dedicated stores and place a combined
order to the vendor. The vendor will then ship to each of the RDCs where ShopCO “mixes”
the products from multiple suppliers to distribute a single combined load each store.

189
Periodic Review Policies (R,S)
New Mixing Center Strategy

Find (R,S) ordering policy for Hurricanes for store 1301 given
Forecasted annual demand of Hurricanes drilss is N(3400,400)
Desired CSL 95%
Lead Time is now 10 days (call this 1.5 weeks for simplicity)
Review Periodic is reduced to 2 weeks
ShopCo RDC do not have a minimum order quantity MOQ to stores (why?)
Orders still need to be in multiples of 12 drills to fit on pallets (why?)
What is the expected annual cost of cycle and safety stock?

190
Periodic Review Policies (R,S)

191
Key Points
Inventory Performance metrics
Service Based IFR / CSL
Cost Based CSOE vs CIS
Imputed vs Implied metrics
Designing to one metric sets the other
Can backwards calculate implied values
Periodic Review (R,S)
Very commonly used
Use the (s,Q) rules with simple transformations
Q = D*R. / s= S / L=L+R
Changing L & R have different impacts on Inventory

192
 1. Procurement and Sourcing

2. Mapping the buy

3. Value risk
Agenda 4. Process Sourcing
Part II – Procurement 5. Capital Goods
and Sourcing 6. Outsourcing

7. Purchasing

193
 1. Procurement and Sourcing

2. Mapping the buy

3. Value risk
Agenda 4. Process Sourcing
Part II – Procurement 5. Capital Goods
and Sourcing 6. Outsourcing

7. Purchasing

194
The River Rouge Plant

195
The River Rouge Plant
Profit

Wages, salaries, overhead

Materials and Services

196
The leverage (and why managers focus on price)
Strategic sourcing efforts can have a significant impact on the financial performance and
shareholder value of a company

Illustrative Example

“When the goal

is boosting
profits by
dramatically
lowering cost, a
business should
look first to what
it buys” Fortune
1995

197
But: The price iceberg

198
 1. Procurement and Sourcing

2. Mapping the buy

3. Value risk
Agenda 4. Process Sourcing
Part II – Procurement 5. Capital Goods
and Sourcing 6. Outsourcing

7. Purchasing

199
What do we buy (Automotive) ?

• How many we buy?

• How much does each cost?
• How unique is the part ?
• How many suppliers?

200
What do we buy (Fast Food) ?

• How many we buy?

• How much does each cost?
• How unique is the part ?
• How many suppliers?

201
What do we buy (Computers) ?

• How many we buy?

• How much does each cost?
• How unique is the part ?
• How many suppliers?

202
Value and Risk Mapping
Risk/impact

Complex Market
High Few suppliers
Restricted Capacity
Unique specifications
No Substitutes

Simple market
Low Many suppliers
Excess Capacity
Standard specifications
Possible Substitutes

Low High Annual Spend $$

203
Value and Risk Mapping
Risk/impact

High

Low

Low High Annual Spend $$

204
Value and Risk Mapping
Risk/impact

Critical Strategic
High
Potential problem Competitive advantage

Tactical Leverage
Low
Common Items Generics

Low High Annual Spend $$

205
Tactical buy
Many transaction; low value

• Transaction cost are high relative to items value

Main strategy: lower the number of transactions.

• Use procurement card

• Supplier managed inventory / consignment inventory / VMI

• System contracting

• EDI

206
Leverage buy
Generic items; high volume
• This where much of the $$$ is spent.

Conduct auctions
• Typically: sealed bid/ first price auctions

Minimize total landed cost (TLC)

• Ready to switch suppliers based on TLC

• Continuously analyze the supply base to be aware of new suppliers
• Keep contracts short and flexible

Volume leveraging (+spot when required)

• Concentrate purchase across divisions
• Add potential volume to suppliers
• Join/ organize a horizontal consortium / horizontal collaboration
• Strategy should assure supply continuity

207
Critical buy
Limited volume but a bottleneck
• Includes: customs-designed tools, capital equipment, specialty support services,
specialty items

Decrease product variety

• Reduce number of SKU/standardize items/services
• Develop method to manage assets over their life time
• Qualify used product/remanufacture

Ensure availability
• Long term contracts
• High levels of Safety Stocks
Should cost analysis
Look for alternatives Model drivers
• Items/ suppliers Use internal comparations
Engineering analysis

208
Strategic buy
Strategic items/service for competitive advantage

Establish partnerships

• Partnerships agreement/ relations at all levels

• Long term contracts possible with gain sharing/revenue sharing
• Join product development
• Innovation cooperation
• Possible co-investment

Possible vertical integration

• For risk reduction; sustainability ; innovation

• Note: supplier’s customers come with it (some may disappear)

209
 1. Procurement and Sourcing

2. Mapping the buy

3. Value risk
Agenda 4. Process Sourcing
Part II – Procurement 5. Capital Goods
and Sourcing 6. Outsourcing

7. Purchasing

210
Value and Risk Mapping Strategies
Risk/impact

High • Reduce risk • Strategic alliances

• Eliminate • Shared cost reductions
• Substitute • Partnerships
• Simplify • Limited active sourcing
• Supplier development

• Streamline • Maximize leverage

acquisition process • Standardization
• Reduce activity • Consolidated volumes
Low • Minimize # of • Reduce transaction cost
Transactions • Global Sourcing
• VMI • Active Sourcing

Low High Annual Spend $$

211
Value and Risk Mapping Strategies
Risk/impact

High

Increase value and

partner with supplier

Find more suppliers or Lower complexity and

change engineering consolidate buy partner with
Low specifications lower others to increase volume
complexity

Low High Annual Spend $$

212
e-markets
Public
• For MRO in horizontal markets
• Wide reach
• High transactional efficiency

Consortia (industry sponsored)

• Within a vertical
• Volume aggregation
• Transportation efficiencies

Private e -markets
• Security
• Access to designs
• Technology & engineering applications
• Collaborative systems to manage quality

213
Value and Risk Mapping e-Procurment
Risk/impact

High
Extra nets No
Industry portals recommended

Supplier e- Reverse Auctions

Low Catalogue Buy Manual combine Volumes

Low High Annual Spend $$

214
 1. Procurement and Sourcing

2. Mapping the buy

3. Value risk
Agenda 4. Process Sourcing
Part II – Procurement 5. Capital Goods
and Sourcing 6. Outsourcing

7. Purchasing

215
The sourcing process
Confirm category definition
Validate baseline
1 information
Identify company customers
Develop specs
Internal Assessment Identify key constituents
Identify sourcing levers
Understand currentDevelop end-state scenarios
purchasing processDetermine potential mega
suppliers
4 5 6 7 with short listed
Negotiation
Develop RFP Evaluation Develop category
supplier
Criteria implementation plan
2 Sourcing Bidding Negotiate
Decide
Listen to service
Contract
on bidding format
not
included in theDevelop
Implement bid communication
Market Assessment Strategy
Analyze markets Process select
Develop supplier message
Select suppliersplan
dynamics/trends Develop RFP Develop measurement and
Contract
Identify supplier universe Conduct bid audit plan
What do competitors do? Short list suppliers Capture intellectual capital

Collect Supplier 3
information
Supplier survey
EvaluationEnsure
criteria Capture Measure &
Compliance
Verify spend analysis Lessons Report
216
Feedback Loop

Next Year / Ensure Capture Measure

Next Contract Compliance Lessons & Report

217
 Evaluating suppliers
Cost Competitiveness

Quality
Administration

Logistics Technology/systems
Improvement

Sustainability
Responsiveness

218
Innovation
Evaluating suppliers

In class:
• Analytic Hierarchy
• Comparative Chart

219
Key sourcing levers
Leverage buying power

Product/Service specification rationalization

Joint process improvement

Relationships restructuring

Global sourcing

220
Be a good Customer

221
Be a good Customer
• How often do you conduct a supplier survey to find out how easy it is to do business with you?

• Don’t leave the contract to the lawyers – future users must be involved
• Even in tight contracts a lot is left out and rely on people and understanding
• When a contract is thrown by procurement / legal “over the fence” it can be only record for both
supplier and customers and it may not reflect needs.
• Smaller companies are better
• They rely more on the suppliers
• Not shy about asking for help, ideas and innovation

• Help critical suppliers when times are tought

• Example: P&G during 2008 giving LT contracts; Ussing its credit to help suppliers obtain
financing; investing in suppliers

222
 1. Procurement and Sourcing

2. Mapping the buy

3. Value risk
Agenda 4. Process Sourcing
Part II – Procurement 5. Capital Goods
and Sourcing 6. Outsourcing

7. Purchasing

223
Purchasing Dichotomy

224
Capital Goods Purchasing
Beyond Standard purchasing
• Emphasis on life cycle costing
• Estimation of residual value
• Products Trial
• Lease/hire/buy comparison
• Financial considerations:
• Taxes
• Government subsides
• Social environmental considerations

225
Lifetime Cost of Capital Items

Source: AT Kearney 226

Watch for:
Long approval processes
• When approved – the supplier is notified prematurely (before contracting completed),
creating supplier leverage.

Purchasing department should insist on enough time for negotiation and contracting to be
built into the process

Include performance criteria and guarantees in the contract

227
 1. Procurement and Sourcing

2. Mapping the buy

3. Value risk
Agenda 4. Process Sourcing
Part II – Procurement 5. Capital Goods
and Sourcing 6. Outsourcing

7. Purchasing

228
Handling Volatility – Volatility
Component Pricing
Fuel, raw material cost are volatile and are likely to remain so.

Two basics methods:

1. Hedging (financial and physical)
2. Separate fixed and variable cost

229
Financial Hedging
1. Simple Hedge:
• Negotiate long term, fixed price contract, in the company’s preferred currency

2. Forward contract :
• Buy/sell the commodity or a related one for future delivery on a given date at given
price

1. Option:
• A call/put option = the right to buy/sell at a certain price at a certain future date

230
Financial Option
• A buy(sell) option is a contract that gives the option holder the right, but not the obligation
to buy or sell something at a given price regardless of the prevailing market price

• Example 1: Current market price is a key material is $ 100/unit. A company call option to
buy it at $ 120 / unit on or before some future date.
• If the market price in future is $140, the company can exercise the option and buy at
$ 120
• If the price is $110, the company does not exercise and buys at the market price $
110

• Example 2: commodity producer contracts for a put option to sell its product at $ 25/unit

• If the price falls he exercises the option and sells for $ 25/unit
• If the market price increases , he does not exercise and sells for a higher price

231
Financial Option
• The downside:
• Option cost money
• They expire on a certain date
• They are worthless if the price does not move beyond the established bounds

• Options act like insurance

• A premium for a contract that covers certain risk
• Particularly useful in volatile times (and more expensive then)
• More expensive to cover small fluctuation and for long time.

• Note
• Such contract are assets on the company’s balance sheet
• Example: a large decline in the price of fuel at the end of 2014 forced DeltaAirlines to
project a $1.2 billion write off
• At the same time American Airlines, which does not hedge the price of fuel, enjoyed
windfall profits
232
Physical hedging
• Create conditions in which the fluctuations are mitigated “naturally”. (used mainly for
currency hedging)
• Examples:
• Build a plant in countries where labor rates and currency are not expected to
appreciate
• Manufacture and sell in the same country
• Actually buy commodity when price is low

233
Fix + Variable Price
• Problem: both sides want a long term contract but the price of a key commodity for the
supplier is volatile
• Example basic transportation + fuel
• Example: basic corrugated packaging + pulp
• Solution: tie the long term contract to the basic contract function + tie the volatile
component to a neutral index
• Example: fuel for a transportation contract

Extra payment
based on index

Long term contract with specified

price

234
Fix + Variable Price
• Issues:
• Index vs actual buying price ( e.g, retail/wholesale)
• Assume usage (e.g, productivity/empty miles, % of commodity in the product)
• Assume efficiency (eg. Miles / gallon; scrap for the vendor)

• Goals:
• Customer: Long term stability; drive the supplier towards efficiency
• Supplier: Cover cost (and profits); long term stability

235
Outsourcing
Moving a set of activities/function/services to a contractor

External supplier has better capability

External supplier has greater or more appropriate capacity

Freeing recourses for other purposes

Reduction in operating costs

Infusion of cash by selling assets to provider

Reducing or spreading risk

Desire to focus more tightly on core business

Economies of scale of supplier

236
Main Contributors to Success
Activity well defined

Roles and responsibilities of parties clear

Good relationship with supplier

High quality of supplier

Effective contract management / ,monitoring

Single point of contact
Effective quarterly business review
Regular site visits
Keep the KPIs current
Communicate, communicate, communicate

237
Key contractual elements
• Comprehensive service definition – what is actually required?

• Process for service evolution – ongoing continues improvement; audit reporting

procedures

• Ability to add/delete service

• Volume change procedures

• Service levels (meaningful measure targets KPIs)

• Service credits/bonus (share risk and reward)

• Objectives to delivered by both sides

• Acceptance process

238
Make vs Buy

239
Advantages of Outsourcing
Flexibility: convert fixed cost to variable cost
• Providing flexibility in adjusting capacity (both up and down)
• Balance work fore requirement

Reduce capital investment requirements

Accelerate new product development

Reduce cost via suppliers economies of scale and lower wage structure

Gain access to innovation and innovation from supplier

Gain access to new markets

Focuses resources on high value added activities (core competences)

240
Problems with offshore Outsourcing
• Labor advantages shrink as countries mature and as direct labor continues to
became a smaller part of the total cost

• Supply chain management is more difficult with off shore suppliers

• Lead time may be a problem with suppliers

• Security considerations put into question the value of offshore procurement

241
The Strategic Risk
• Creating a competitor
• 1914 the Dodge Brothers turn from ford engine supplier to competitor
• Japanese consumer electronic industry started with contracting for US
firms for radio receivers also adapted transistor faster
• Japanese aircraft industries?

• Losing control of the channel to a supplier

• IBM in 1980 designed a PC, the manufacturing process and the value
chain
• Contracted to Microsoft and Intel
• ”Windows Machine” and “Intel Inside”

• Losing control of the channel to a customer

• P&G and WalMart => WalMart Outside?

242
 1. Procurement and Sourcing

2. Mapping the buy

3. Value risk
Agenda 4. Process Sourcing
Part II – Procurement 5. Capital Goods
and Sourcing 6. Outsourcing

7. Purchasing

243
The Three Hurdles to Success
• Meet/exceed the market demands

• Ahead of the competition

• Meet/exceed the regulatory demands

• Of Government

• Meet/exceed the social demands

• Of civil society

244
Is it CRS? – A Range of Activities

245
A range of Procurement Activities
• Preparing code of conduct

• Example IWAY

• Audit

• Example: Intel (conflict minerals)

• Training suppliers

• Example Starbuks

• Supply chain transparency

• Example: Patagonia
246
What are the 6 Principles of Persuasion?

1. Reciprocity
2. Commitment and Consistency
3. Social Proof
4. Authority
5. Liking
6. Scarcity

Professor Emeritus of Psychology and Marketing at

Arizona State University. Influence has sold over 3 million
copies, is a New York Times Bestseller and has been
published in over 30 languages. 247
The setting: Go Make Change Happen

You are promoting a CHANGE PROGRAM.

Some just don’t care
about your issue,
There is a set of decision makers: but
20% support your issue
Some care very
60% are neutral*
much but are
20% oppose your issue undecided.

You need to create a majority of support.

248
Reciprocity
Reciprocity – People tend to return a favor
- If someone does a favor for me I feel some obligation to do a favor for them.
- Create an obligation: Giving free samples in marketing, Windshield washers in poor
countries at intersections

Problem:
- You do a big favor for someone
- They say, “Oh, thank you so much.”
- You say, “Oh, don’t mention it. It was nothing.”

…. Wrong answer!!! You just missed the chance to create an obligation

You should have said:

- “Ah, well, my friend. This is the kind of thing that partners do for each other. We have
to help each other out, you know.”

249
 How to use Reciprocity
• Identify a person who you want to influence
• Determine what they need and how you can do them a favor
• Do the favor ( but say nothing about it.)
• Give them an opportunity to thank you (be subtle)
• “ Ah, well, my friend. This is the kind of thing that partners do for each other. We
have to help each other out.”
• Later you are in a stronger position as you ask this person for their support of your
issue.

250
How to use Commitment and Consistency?
• As you try to line up enough supporters of your issue …

• Meet with key decision makers privately, in the absence of opposing points of view

• Win a commitment of support from the decision maker

• Have their commitment become public knowledge

• Opposing voices will try to turn that vote around

• Use the pressure of Commitment and Consistency to prevent that decision maker
from backsliding.

251
Commitment and Consistency
Commitment and Consistency – People don’t like to renege
- If I make a commitment to support something or someone it is a matter of HONOR to
me to fulfill that commitment
- This is true even if the original conditions have changed
- This is a very powerful force in most people (maintain HONOR)
- Create the conditions to get a commitment: Republicans who supported Donald
Trump, now afraid to back away from him.

In Politics
- Even when new information comes to light, candidates are very reluctant to change
their position on an issue --- get accused of flip-flopping (Roy Moore example).

252
Social Proof
Social Proof – People will do things that they see other people are doing

- Conformity is a very strong force in society (avoid being weird or different)

- Think of fashions and trends in culture and style, teenagers

- People are more likely to CONFORM to someone who is like themselves and who
they trust.

In Politics
- People will be influenced more by one of their own.
- At town meeting, instead of the Senator making the argument, she arranges for a
local farmer to stand up and make the argument instead.

253
How to use Social Proof?
• Identify a person or group that you want to influence
• Determine who they associate with, consult with, a peer
• Seek a peer in that circle that supports your issue
• Meet with the peer and recruit him/her to help promote your issue …. Have it become
THEIR issue also.

• Have the peer add their voice and use their influence to support the issue

254
How to use Social Proof?
• Identify the main arguments against your change program
• Document numerous companies similar to yours that have solved the same
problems w/ your change program.
• Overwhelm the opponents with many examples of similar companies (including
their competitors) who have improved operations by making your proposed
changes.
• Organize benchmarking visits with those companies so their testimonials are heard.
• Make it seem like “everyone else is doing this.”

• Examples: the original rollout of SAP, outsourcing to China

255
Authority
Authority – People will tend to obey authority figures
- Even if they are asked to do things that they don’t really agree with
- People will believe that an authority figure knows what should be done
- Experts are seen as authority figures in their field of practice
- Authority figures: people follow “Doctor’s orders,” people pay big money to fix car
problems because they believe their auto mechanic

In Business:
• Boardrooms pay big money for a
“turnaround specialist” to come in
and take over control of a failing
company

256
How to use Authority?
• Understand the decision-makers that you need to influence
• Identify their concerns & source of opposition to your issue
• Have everyone understand & acknowledge what the points of concern are
• Bring in a senior recognized expert (authority figure) to chat with the decision makers
• “I’ve seen this same problem many times at other companies. Here’s how you should
deal with it …..”
• Which happens to support your change program.

257
Liking
Liking – People are easily persuaded by people they like.
- Friends get instant access (don’t need to set up a meeting)
- When a friend tries to persuade you, you consider not only the merit of the argument
but also the value of the friendship
- Beautiful people are used in advertisements since people like them more / faster.

In Sales:
- Pyramid schemes (Tupperware, Amway, Mary Kay
Cosmetics) work great for friendly extroverted likable
people
- Gather your friends together for coffee and then
sell them plastic stuff. The friends know they are
getting ripped off but go anyhow to avoid saying “No.”

258
How to use Liking?
• Identify the group that you want to influence
• Have your management invent a new “rotational program” for you to “get breadth of
experience”
• Have him/her assign you to the group to be influenced
• You transfer to the target group and add lots of value
• Your headcount is paid for by corporate
• Become a trusted member of the target group, develop relationships – and a much
deeper understanding of how that function operates
• Slowly begin to promote your change program leveraging your new access and
friendships (industrial implants)

259
Scarcity
Scarcity – Perceived scarcity will generate demand.
- Retail sales: “Limited time offer” “Sale ends tomorrow”
- Airline booking: “Only 2 seats left at this price”

Product Sales
- New iPhone -- people lined up around the block to be the first ones to own the latest
iPhone
- Tickle Me Elmo (stuffed animal that speaks) – very short supply before Christmas,
people paid $200 each
- Rare coins and stamps -- the fewer that were made, the greater the demand
- Hard Rock Café – poor jewelry fill rate à raises demand!!!

260
How to use Scarcity?
• Think of the people who line up to be first to buy the iPhone
• They want to have something that is scarce, to get ahead of fellow geeks.
• Having the first iPhone puts them ahead of their competitors
• Present your change program the same way
• “We can be one of the leaders, one of the very few companies to adopt this new
idea.”
• “We can get an advantage over our competitors if we act quickly.”

261
Practice Scenarios
• Form up in teams of 3-4

• Meet with your team and write down your approaches to the following two practice
scenarios. Refer to the handout sheet.
• You are going to have 20 minutes to do this.

• Scenario 1. Centralize Transportation Purchasing

• Scenario 2. Flatten the Hockey Stick

• Be prepared to describe your approach to the class.

262
Practice Scenarios
• Your company has 8 DC spread across North America
• Each has a Transportation Manager
• Each selects its own trucking companies

• Overall your company is using 250 trucking companies

• You are new to the company and work for the VP of SC.
• You have no budget, no authority, & don’t know anyone.
• You are told to go make centralized procurement happen

• Describe which of the 6 tools you will use and how.

263
Practice Scenarios
• The Salesmen are compensated on monthly sales targets.
• 80% of the orders are filed in the last 4 days of the month
• The Warehouse incurs huge labor costs in temps and overtime to get these orders out
the door by midnight.

• You are new to the company and work for the VP of SC.
• You have no budget, no authority, & don’t know anyone.

• You are told to go to Sales and flatten out this hockey stick.

• Describe which of the 6 tools you will use and how.

264
Gracias por su
Atención!