D&M The Supply Chain – Chapter 2 – Inventory Management and Risk Pooling – Flashcards

• Raw material inventory. • Work-in-process (WIP) inventory. • Finished product inventory. Simchi-Levi (2007), C2, P49

1 . Unexpected changes in customer demand. 2. The presence in many situations of a significant uncertainty 3. Lead times 4. Economies of scale offered by transportation companies Simchi-Levi (2007), C2, P49

a. The short life cycle of an increasing number of products b. The presence of many competing products in the marketplace. Simchi-Levi (2007), C2, P49

The strategy, approach, or set of techniques used to determine how to manage inventory Simchi-Levi (2007), C2, P50

1. First and foremost is customer demand 2. Replenishment lead time 3. The number of different products being considered. 4. The length of the planning horizon. 5. Costs, including order cost and inventory holding cost. 6. Service level requirements Simchi-Levi (2007), C2, P50

a. Typically, order cost consists of two components: the cost of the product and the transportation cost. The product cost may exhibit economies of scale; that is, the larger the order quantity, the smaller the per-unit price. b. Inventory holding cost, or inventory carrying cost, consists of i. State taxes, property taxes, and insurance on inventories. ii. Maintenance costs. iii. Obsolescence cost, which derives from the risk that an item will lose some of its value because of changes in the market. iv. Opportunity costs, which represent the return on investment that one would receive had money been invested in something else (e.g., the stock market) instead of inventory. Simchi-Levi (2007), C2, P50

a simple model that illustrates the trade-offs between ordering and storage costs (optimal order quantity). Consider a warehouse facing constant demand for a single item. The warehouse orders from the supplier, who is assumed to have an unlimited quantity of the product. Simchi-Levi (2007), C2, P51

1. An optimal policy balances inventory holding cost per unit time with setup cost per unit time. 2. Total inventory cost is insensitive to order quantities; that is, changes in order quantities have a relatively small impact on annual setup costs and inventory holding costs. Simchi-Levi (2007), C2, P52

D = Demand per day K = Fixed setup cost for each order h = Holding cost per item per day it's held Q* = √2KD/h Simchi-Levi (2007), C2, P52

1. The forecast is always wrong. 2. The longer the forecast horizon, the worse the forecast. 3. Aggregate forecasts are more accurate. Simchi-Levi (2007), C2, P53

product that has a short lifecycle and hence the firm has only one ordering opportunity. Simchi-Levi (2007), C2, P53

The use of historical data from past years, current economic conditions and other factors to construct a forecast that suggest suggests that average demand is about X units, but there is a probability that demand will be either larger than average or smaller than average. Simchi-Levi (2007), C2, P53

To identify the best production quantity, the firm needs to understand the relationship between the production quantity, customer demand, and profit. P = Selling price C = cost price Q = selling quantity K = fixed production cost SP = salvage value SQ = salvage quantity Profit = P(Q) + SP(SQ) − C(Q) − K Simchi-Levi (2007), C2, P54

• The optimal order quantity is not necessarily equal to forecast, or average, demand. Indeed, the optimal quantity depends on the relationship between marginal profit achieved from selling an additional unit and marginal cost. More importantly, the fixed cost has no impact on the production quantity, only on the decision whether to produce or not. Thus, given a decision to produce, the production quantity is the same independently of the fixed production cost. • As the order quantity increases, average profit typically increases until the production quantity reaches a certain value, after which the average profit starts decreasing • As we increase the production quantity, the risk—that is, the probability of large losses—always increases. At the same time, the probability of large gains also increases. This is the risk/reward tradeoff Simchi-Levi (2007), C2, P56

If Production Demand Probability profit = ((Demand * Sales Price) + ((Production - Demand) * Salvage Price) - (Production * Purchase Price)) * Probability Sum all probability profits to get expected profit for the Distributor Simchi-Levi (2007), C2, P56

1. To satisfy demand occurring during lead time. Since orders aren't met immediately, inventory must be on hand to meet customer demand that is realized between the time that the distributor places an order and the time that the ordered inventory arrives. 2. To protect against uncertainty in demand. 3. To balance annual inventory holding costs and annual fixed order costs. We have seen that more frequent orders lead to lower inventory levels and thus lower inventory holding costs, but they also lead to higher annual fixed order costs. Simchi-Levi (2007), C2, P58

Continuous review policy, in which inventory is reviewed continuously, and an order is placed when the inventory reaches a particular level, or reorder point. This type of policy is most appropriate when inventory can be continuously reviewed—for example, when computerized inventory systems are used. Periodic review policy, in which the inventory level is reviewed at regular intervals and an appropriate quantity is ordered after each review. This type of policy is most appropriate for systems in which it is impossible or inconvenient to frequently review inventory and place orders if necessary. Simchi-Levi (2007), C2, P58

AVG / µ= Average daily demand faced by the distributor STD / σ= Standard deviation of daily demand faced by the distributor L = Replenishment lead time from the supplier to the distributor in days h = Cost of holding one unit of the product for one day at the distributor z = service level (α, β and γ). This implies that the probability of stocking out is 1 - α Simchi-Levi (2007), C2, P59

z = service level (α, β and γ). This implies that the probability of stocking out is 1 - α Service Level expresses the probability of being able to service a demand within a reference period without delay from stock on hand. • α service level (type 1): Event-oriented performance measure • β service level (type 2): Quantity oriented performance measure • γ service level: Time and quantity performance measure Simchi-Levi (2007), C2, P59

the higher the service level, the higher the inventory level. the longer the lead time, the lower the level of service provided with the same inventory level. the lower the inventory level, the higher the impact of a unit of inventory on service level. Service level will be higher for products with: High profit margin. High volume. Low variability. Short lead time. Simchi-Levi (2007), C2, P63

Risk pooling suggests that demand variability is reduced if one aggregates demand across locations. This is true since, as we aggregate demand across different locations, it becomes more likely that high demand from one customer will be offset by low demand from another. This reduction in variability allows a decrease in safety stock and therefore reduces average inventory. To understand risk pooling, it is essential to understand the concepts of standard deviation and coefficient of variation of demand. Standard deviation is a measure of how much demand tends to vary around the average, and coefficient of variation is the ratio of standard deviation to average demand: Simchi-Levi (2007), C2, P64

Safety stock. Clearly, safety stock decreases as a firm moves from a decentralized to a centralized system. Service level. When the centralized and decentralized systems have the same total safety stock, the service level provided by the centralized system is higher. Overhead costs. Typically, these costs are much greater in a decentralized system because there are fewer economies of scale. Customer lead time. Since the warehouses are much closer to the customers in a decentralized system, response time is much shorter. Transportation costs. The impact on transportation costs depends on the specifics of the situation. Simchi-Levi (2007), C2, P67