Inventory Management, Supply Contracts and Risk Pooling Phil Kaminsky kaminsky@ieor. David...

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Transcript of Inventory Management, Supply Contracts and Risk Pooling Phil Kaminsky kaminsky@ieor. David...

  • Slide 1
  • Inventory Management, Supply Contracts and Risk Pooling Phil Kaminsky kaminsky@ieor.berkeley.edu David Simchi-Levi Philip Kaminsky Edith Simchi-Levi
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Outline of the Presentation Introduction to Inventory Management The Effect of Demand Uncertainty (s,S) Policy Periodic Review Policy Supply Contracts Risk Pooling Centralized vs. Decentralized Systems Practical Issues in Inventory Management
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  • Supply Sources: plants vendors ports Regional Warehouses: stocking points Field Warehouses: stocking points Customers, demand centers sinks Production/ purchase costs Inventory & warehousing costs Transportation costs Inventory & warehousing costs Transportation costs
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Inventory Where do we hold inventory? Suppliers and manufacturers warehouses and distribution centers retailers Types of Inventory WIP raw materials finished goods Why do we hold inventory? Economies of scale Uncertainty in supply and demand Lead Time, Capacity limitations
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Goals: Reduce Cost, Improve Service By effectively managing inventory: Xerox eliminated $700 million inventory from its supply chain Wal-Mart became the largest retail company utilizing efficient inventory management GM has reduced parts inventory and transportation costs by 26% annually
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Goals: Reduce Cost, Improve Service By not managing inventory successfully In 1994, IBM continues to struggle with shortages in their ThinkPad line (WSJ, Oct 7, 1994) In 1993, Liz Claiborne said its unexpected earning decline is the consequence of higher than anticipated excess inventory (WSJ, July 15, 1993) In 1993, Dell Computers predicts a loss; Stock plunges. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write downs (WSJ, August 1993)
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Understanding Inventory The inventory policy is affected by: Demand Characteristics Lead Time Number of Products Objectives Service level Minimize costs Cost Structure
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Cost Structure Order costs Fixed Variable Holding Costs Insurance Maintenance and Handling Taxes Opportunity Costs Obsolescence
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi EOQ: A Simple Model* Book Store Mug Sales Demand is constant, at 20 units a week Fixed order cost of $12.00, no lead time Holding cost of 25% of inventory value annually Mugs cost $1.00, sell for $5.00 Question How many, when to order?
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi EOQ: A View of Inventory* Time Inventory Order Size Note: No Stockouts Order when no inventory Order Size determines policy Avg. Inven
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi EOQ: Calculating Total Cost* Purchase Cost Constant Holding Cost: (Avg. Inven) * (Holding Cost) Ordering (Setup Cost): Number of Orders * Order Cost Goal: Find the Order Quantity that Minimizes These Costs:
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi EOQ:Total Cost* Total Cost Order Cost Holding Cost
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi EOQ: Optimal Order Quantity* Optimal Quantity = (2*Demand*Setup Cost)/holding cost So for our problem, the optimal quantity is 316
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi EOQ: Important Observations* Tradeoff between set-up costs and holding costs when determining order quantity. In fact, we order so that these costs are equal per unit time Total Cost is not particularly sensitive to the optimal order quantity
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi The Effect of Demand Uncertainty Most companies treat the world as if it were predictable: Production and inventory planning are based on forecasts of demand made far in advance of the selling season Companies are aware of demand uncertainty when they create a forecast, but they design their planning process as if the forecast truly represents reality Recent technological advances have increased the level of demand uncertainty: Short product life cycles Increasing product variety
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Demand Forecast The three principles of all forecasting techniques: Forecasting is always wrong The longer the forecast horizon the worst is the forecast Aggregate forecasts are more accurate
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime Sporting Goods Fashion items have short life cycles, high variety of competitors SnowTime Sporting Goods New designs are completed One production opportunity Based on past sales, knowledge of the industry, and economic conditions, the marketing department has a probabilistic forecast The forecast averages about 13,000, but there is a chance that demand will be greater or less than this.
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Supply Chain Time Lines Jan 00Jan 01Jan 02 Feb 00 Sep 00Sep 01 DesignProductionRetailing Feb 01 Production
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime Demand Scenarios
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime Costs Production cost per unit (C): $80 Selling price per unit (S): $125 Salvage value per unit (V): $20 Fixed production cost (F): $100,000 Q is production quantity, D demand Profit = Revenue - Variable Cost - Fixed Cost + Salvage
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime Scenarios Scenario One: Suppose you make 12,000 jackets and demand ends up being 13,000 jackets. Profit = 125(12,000) - 80(12,000) - 100,000 = $440,000 Scenario Two: Suppose you make 12,000 jackets and demand ends up being 11,000 jackets. Profit = 125(11,000) - 80(12,000) - 100,000 + 20(1000) = $ 335,000
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime Best Solution Find order quantity that maximizes weighted average profit. Question: Will this quantity be less than, equal to, or greater than average demand?
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi What to Make? Question: Will this quantity be less than, equal to, or greater than average demand? Average demand is 13,100 Look at marginal cost Vs. marginal profit if extra jacket sold, profit is 125-80 = 45 if not sold, cost is 80-20 = 60 So we will make less than average
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime Expected Profit
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime Expected Profit
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime: Important Observations Tradeoff between ordering enough to meet demand and ordering too much Several quantities have the same average profit Average profit does not tell the whole story Question: 9000 and 16000 units lead to about the same average profit, so which do we prefer?
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi SnowTime Expected Profit
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Probability of Outcomes
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Key Insights from this Model The optimal order quantity is not necessarily equal to average forecast demand The optimal quantity depends on the relationship between marginal profit and marginal cost As order quantity increases, average profit first increases and then decreases As production quantity increases, risk increases. In other words, the probability of large gains and of large losses increases
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Manufacturer Manufacturer DC Retail DC Stores Fixed Production Cost =$100,000 Variable Production Cost=$35 Selling Price=$125 Salvage Value=$20 Wholesale Price =$80 Supply Contracts
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Demand Scenarios
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Distributor Expected Profit
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Distributor Expected Profit
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Supply Contracts (cont.) Distributor optimal order quantity is 12,000 units Distributor expected profit is $470,000 Manufacturer profit is $440,000 Supply Chain Profit is $910,000 Is there anything that the distributor and manufacturer can do to increase the profit of both?
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Manufacturer Manufacturer DC Retail DC Stores Fixed Production Cost =$100,000 Variable Production Cost=$35 Selling Price=$125 Salvage Value=$20 Wholesale Price =$80 Supply Contracts
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Retailer Profit (Buy Back=$55)
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  • 2003 Simchi-Levi, Kaminsky, Simchi-Levi Retailer Profit (Buy Back=$55) $513,800
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  • 2003 Simchi-Levi, Kaminsky, Simchi-