Supply Chain Management (SCM)

• Supply Chain: the sequence of organizations - their facilities, functions, and activities - that are involved in producing and delivering a product or service. (Value Chain or Demand (Chain)

• Facilities– Warehouses, Factories, Processing centers, Warehouses, Factories, Processing centers,

Distribution centers, Retail outlets

11-1

A Typical Structure of SCM

Consumer Consumer Consumer Consumer

Retailer Retailer Retailer Retailer

Distributor Distributor

Manufacturers

1st tier Suppliers

2nd tier Suppliers

11-2

A Typical Chain

Production Distribution

Purchasing Receiving Storage Operations Storage

11-3

Reasons for the Existence of Supply Chain

• Increasing levels of outsourcing• Competitive pressures• Competitive pressures• Increasing globalization• Complexity of supply chains

11-4

Benefits through SCM

Organization Benefit

Campbell Soup Doubled inventory turnover rate

Hewlett-Packard Cut supply costs 75%

Sport Obermeyer Doubled profits and increased sales 60%

National Bicycle Increased market share from 5% to 29%

Wal Mart Largest and most profitable retailer in the worldWal-Mart Largest and most profitable retailer in the world

11-5

Elements of Supply Chain Management

Typical IssuesElement

Predicting quantity and timing of demandForecasting

Determining what customers wantCustomers

Controlling quality, scheduling workProcessing

Incorporating customer wants, mfg., and timeDesign

Evaluating suppliers and supporting operationsPurchasing

Meeting demand while managing inventory costsInventory

Determining location of facilitiesLocation

Monitoring supplier quality, delivery, and relationsSuppliers

g pp pp g pg

Deciding how to best move and store materialsLogistics

g

11-6

Chapter 12Chapter 12

Inventory ManagementInventory Management

Independent Demand(Chapter 12)

A Dependent Demand(Ch )

B(4) C(2)

(Chapters 14)

B(4) C(2)

D(2) E(1) D(3) F(2)

Independent demand is uncertain. Dependent demand is certain.11-8

p p

Definition of InventoryDefinition of Inventory• The stock of any items or resources used The stock of any items or resources used

in an organization

11-9

Examples of Inventories

• Raw materials & purchased parts• Partially completed goods called • Partially completed goods called

work in progress (WIP)• Finished-goods inventories• Replacement tools & suppliesReplacement, tools, & supplies• Goods-in-transit (pipeline) to warehouses

or customers

11-10

Supplier – Production – Distribution SystemSupplier – Production – Distribution System

11-11

fFunctions of Inventory

• Meet demand during order cycle (Cycle inventory)

• Protect against stock-outs (Safety stock inventory)• Smooth production requirements (Anticipation Smooth production requirements (Anticipation

inventory)• Decouple components (areas) of the production• Decouple components (areas) of the production-

distribution (Buffer inventory)P it ti (Pi li i t )• Permit operations (Pipeline inventory)

11-12

h f h ldOther reasons for holding inventory

• To take advantage of volume discount• Hedge against price increaseg g p

11-13

O d C lOrder Cycle• Amount of time elapsed between orders

Inventory level

Cycle inventoryy

Order Order

cycleOrder

Order Order

11-14

cycleOrder

Objectives of Inventory Management (1 of 2)

• Achieve satisfactory levels of customer service while keeping inventory costs service while keeping inventory costs within reasonable bounds

• Two fundamental decisionshow much to order– how much to order

– when to place the order

11-15

P ibl f Objectives of Inventory Management (2 of 2)

• Possible performance measures– customer satisfactioncustomer satisfaction

• number of backorders/lost sales• number of customer complaintsnumber of customer complaints

– inventory turnoverf l f d ld• ratio of annual cost of goods sold to average

inventory investment

d f– days of inventory• expected number of days of sales that can be

11-16supplied from existing inventory

I i t t?

Balance Sheet

Is inventory an asset?

Asset Liability

Balance SheetAsset LiabilityCash Interest expense

Account receivable Account payablep yInventory Short-term debtBuilding Long-term debtg g

Land EquityEtc.. Etc..

11-17

Requirements forRequirements forEffective Inventory Managementy g

1. A reliable forecast of demand that includes a f fmeasure of forecast error

2. Knowledge of lead times and lead time variability2. Knowledge of lead times and lead time variability3. An inventory counting system to keep track of the

inventory on hand and on orderinventory on hand and on order4. A classification system for inventory items

bl f h ld5. Reasonable estimates of inventory holding costs, ordering costs, and shortage costs

11-18

1&2. Demand Forecast andLead Time InformationLead Time Information

• Reliable estimates of the amount and Reliable estimates of the amount and timing of demandL d i i i l b • Lead time - time interval between ordering and receiving the orderg g

• Extent of variability in demand and lead timetime

11-19

3. Inventory Counting Systems (1 of 2)

P t l I t (C ti l) S t• Perpetual Inventory (Continual) System– Keeps track of removals from and p

receipts into inventory continuously

• Periodic Systemy– Physical count of items made

at periodic intervalsat periodic intervals

11-20

3. Inventory Counting Systems (2 of 2)

• Cycle counting - taking physical counts of items and reconciling with records on a items and reconciling with records on a continual rotating basis

• Universal Product Code - Bar code Universal Product Code Bar code printed on a label that hasinformation about the item 0information about the item to which it is attached

11-21214800 232087768

4 ABC Cl ifi ti S t4. ABC Classification SystemClassifying inventory according to some measure of y g y gimportance and allocating control efforts accordingly

AA100 — Class C

Class B

AA - very important

BB d i t t valu

e 90 —

80 —Class A

BB - mod. important

CC - least important f dol

lar v 70 —

60 —CC least importanten

tage

of

50 —

40 —Pe

rce

30 —

20 —

11-2210 20 30 40 50 60 70 80 90 100Percentage of items

10 —

0 —

5. Relevant cost elements?1 H ldi i t1. Holding or carrying costs2. Ordering costsg3. Shortage costs

11-23

1. Holding or Carrying CostsC t t it i i t f • Cost to carry a unit in inventory for a length of time

• Includes interest (opportunity cost), insurance taxes depreciation insurance, taxes, depreciation, obsolescence, deterioration

• May be expressed as a percentage of unit price or as a dollar amount per unitp p

11-24

2. Ordering Costs• Cost of ordering and receiving inventory• Include determining how much is needed Include determining how much is needed,

preparing invoices, shipping costs, i ti d i t f tit inspecting goods upon receipt for quantity and quality

• Generally expressed as a fixed dollar amount, regardless of order sizesamount, regardless of order sizes

11-25

3. Shortage Costs• Result when demand exceeds the • Result when demand exceeds the

inventory on hand• Include the opportunity cost of not making

a sales, loss of customer goodwill, late a sales, loss of customer goodwill, late charges, and in the case of internal customers the cost of lost production or customers, the cost of lost production or downtime

• Difficult to measure, thus may have be subjectively estimated

11-26

j y

T B i S t f Two Basic Systems for Independent Demandp

• Fixed-order-quantity systems (Q, R)– basic economic order quantity (EOQ)

model [purchasing model][p g ]– basic economic order quantity model

with incremental or with incremental or noninstantaneous replenishment [ d d ][production order quantity]

– quantity discount model11-27

quantity discount model• Fixed-order-interval systems

How does the basic model How does the basic model How does the basic model How does the basic model work?work? Profile of Inventory Level Over Time

Quantity

on handQ

TimeTime

Economic Economic Economic Economic Order Order Order Order QuantityQuantityQuantityQuantity

B i EOQ M d lBasic EOQ Model• Important Assumptionsp p

– Only one product is involvedAnnual demand requirements are known – Annual demand requirements are known and constantLeadtime is known and orders will be – Leadtime is known and orders will be replenished instantaneouslyConstant price (I e no inflation) – Constant price (I.e., no inflation)

– Two relevant cost components are ordering and inventory holding costsordering and inventory holding costs

11-30

Economic Order QuantityEconomic Order QuantityEconomic Order QuantityEconomic Order Quantity

NotationsD : Annual demand (units/year)

Notations( /y )

S : Ordering cost ($/order)H : Annual inventory holding cost ($/unit)H : Annual inventory holding cost ($/unit)

= I•P where I is interest rate and P is unit purchasing costunit purchasing cost

Q : Order size or quantity (decision variable)

Economic Order QuantityEconomic Order QuantityEconomic Order QuantityEconomic Order QuantityProfile of Inventory Level Over Time

Quantity

on handQ

Average cycle

Q2 y

inventory2

TimeTime

Total Annual Cost

A l A lAnnualcarryingcost

Annualorderingcost

Total cost = +cost cost

Q DQ2 H

DQSTC = +

11-33

Finding Economic Order Finding Economic Order ggQuantityQuantity

olla

rs)

l cos

t (d

Ann

ual

Order size (Q)

Mi i T t l C tMinimum Total CostThe total cost curve reaches its minimum The total cost curve reaches its minimum

where the carrying and ordering costs are equalare equal.

DQ DS22 DS2SQDHQ

=2 H

DSQ 22 =⇒HDSQ 2

=⇒

Q = 2DSH

= 2(Annual Demand )(Order or Setup Cost )Annual Holding CostOPT

11-35

H Annual Holding Cost

Example 2

Annual demand (D) = 9,600 unitsAnnual holding cost (H) = $16/unitg ( ) $ /Ordering cost (S) = $75/order288 days/year288 days/year

• EOQ?

• How many times per year does the store reorder?does the store reorder?

• Length of an order cycle?Length of an order cycle?• Total cost using EOQ?

11-36

Example 3

Annual demand (D) = 3,600 unitsUnit Price (P) = $65( ) $Ordering cost (S) = $31/orderAnnual holding cost (H) = 20% of unit price = 0.2*$65 = $13Annual holding cost (H) 20% of unit price 0.2 $65 $13

• EOQ?

( )( )( )( ) units 1310.2(65)

316003222====

IPDS

HDS

11-37

Basic Fixed Order Quantity ModelWith Incremental ReplenishmentWith Incremental Replenishment

• Differs from the basic EOQ model because orders Differs from the basic EOQ model because orders are assumed to be produced at a uniform rate (p) rather than the order being received rather than the order being received instantaneously.

• It is also assumed that the production rate, p, is t th th t greater than the usage rate, u.

11-38

Profile of Inventory Level Over Time

OQp

Maximum

Inventory

( )Q up - u( )upp

QO −=

Average⎞⎛

Average cycle

inventory( ) 2⎟⎟

⎠

⎞⎜⎜⎝

⎛−up

pQO

pQO=Run time p : production rate u :

usage rate

11-39

usage rate

uQO= timeCycle

Basic Fixed Order Quantity ModelBasic Fixed Order Quantity ModelWith Incremental ReplenishmentQuantity

h d Profile of Inventory Level Over Timeon hand

OQMax Inv.

Start toi

Start torecei e

Receiveorder

TimeFinish

i i 11-40

receive order

receiveorder

orderreceiving order

Basic Fixed Order Quantity ModelBasic Fixed Order Quantity ModelWith Incremental Replenishment

• Figure 11-6 shows the difference between the basic Figure 11 6 shows the difference between the basic EOQ model and this model

• The change in maximum inventory level requires difi ti f th TC timodification of the TC equation

DQ ⎞⎛⎞⎛S

QD H

pp-uQ TC

O

O⎟⎟⎠

⎞⎜⎜⎝

⎛+⎟⎟

⎠

⎞⎜⎜⎝

⎛=

211-41

Qp O ⎠⎝⎠⎝

Basic Fixed Order Quantity ModelWith Incremental ReplenishmentWith Incremental Replenishment

Th i i i l i• The optimization results in

DS2 p: production rate

p-up

HDS QO

2=

p: production rate

u: usage ratep uH

11-42

D 48 000 it / 240 d /

Example 4

D = 48,000 units/year, 240 days/yearS = $45/order, H = $1/unit

800 it /d 200 it /dp = 800 units/day, u = 200 units/day

11-43

Quantity Discount Model (1 of 5)

• This model differs from the basic model because the price per unit (P) may vary because the price per unit (P) may vary with the quantity orderedTh li ff l it i if • The supplier offers a lower unit price if larger quantities are ordered at one time

• This is presented as a price or discount schedule i e a certain unit price covers a schedule, i.e., a certain unit price covers a certain order quantity range

11-44

Quantity Discount Model (2 of 5)

OrderQuantity

Price perBoxQuantity Box

1 to 44 $2.00

45 to 69 1.70

70 or more 1.40

11-45

Quantity Discount (3 of 5)

• Under this condition, annual product cost becomes an incremental cost and cost becomes an incremental cost and must be considered in the d i i f h EOQdetermination of the EOQ

• The total annual costs (TC) = Annual ( )holding cost + annual setup cost +annual product costannual product cost

TC = (Q/2)H + (D/Q)S + DP11-46

Costs Functions Under Quantity DiscountOrder Price perOrderQuantity

Price perBox

1 to 44 $2.00

45 to 69 1 7045 to 69 1.70

70 or more 1.40

O d i11-47

Order size

Quantity Discount (4 of 5)

To find the EOQ, the following procedure is usedis usedBeginning with the lowest price, compute the EOQ for each price level until a feasible EOQ is found using H=IP Q gwhere I is an interest rate and P is purchasing price It is feasible if purchasing price. It is feasible if quantity can be purchased at the price used

11-48

used.

Quantity Discount (5 of 5)If the first feasible EOQ found is for the lowest If the first feasible EOQ found is for the lowest price level, this quantity is the optimal.

hOtherwise, go to step 3.Compute the TC for the EOQ found in Step 2Compute the TC for the EOQ found in Step 2Compute the TC for all price break quantities

t th St 2’ EOQ h di t greater than Step 2’s EOQ where a discount begins. Select the quantity with the lowest TC as the EOQ

11-49

ExampleExample• Annual demand (D) = 936 units( )• Ordering cost (S) = $45/order• Holding cost (H) = 25% of unit price = (0 25)P• Holding cost (H) = 25% of unit price = (0.25)P

OrderQuantity

Price perUnit

1 t 299 $60 001 to 299 $60.00

300 to 499 $58 80300 to 499 $58.80

500 or more $57.0011-50

Example SolutionExample -SolutionOrderQuantity

Price perUnit

1 to 299 $60.00

300 to 499 $58.80

500 or more $57.00

11-51

Setting the Reorder Point

Quantity

on handQ

Reorder point

Place order TimePlace order Time

Leadtime

Basis for Setting the Reorder PointI h fi d d i h • In the fixed order quantity system, the ordering process is triggered when the g p gginventory level drops to a critical point, the reorder point (ROP)the reorder point (ROP)

• This starts all activities associated with l i filli d i i th d placing, filling and receiving the order,

or the lead time for the item

11-53

Basis for Setting the Reorder Point

• During the lead time, customers continue to draw down the inventory leveldraw down the inventory level

• It is during this period that the inventory is g p yvulnerable to stockout (run out of inventory)

• When the demand during the lead time is not • When the demand during the lead time is not known or not constant, a certain amount of i t b th t d inventory above the average or expected demand is carried; this is safety stock (SS)

11-54

Reorder Pointan

tity

Maximum probable demandduring lead timeQ

ua

Expected demandduring lead time

ROP

Safety stock (SS)

11-55LT Time

Leadtime Demand DistributionLeadtime Demand DistributionLeadtime Demand DistributionLeadtime Demand Distribution

Cycle-service level = 85%y

Probability of stockout(1.0 - 0.85 = 0.15)

A erage Average demand

during l d ilead time

SS

ROP

Basis for Setting the Reorder Point• Determinants of the reorder point

– Distribution of demand– Distribution of demand– The length of lead time– Desired customer service level

• Customer service level• Customer service level– is the probability that demand will not

exceed supply during the lead time (order cycle service level )

11-57

( y )

Leadtime Demand DistributionLeadtime Demand DistributionLet’s see how we obtain lead-time demand

distribution from daily demand distribution

More notations d d ti it ( d )

distribution

= average demand per time unit (e.g., day)= standard deviation of demand per day

ddσ p y

l d ti i d

d

= lead time in days = standard deviation of demand during

LTLTσ

11-58

gleadtime

LTσ

Lead Time DistributionsLead Time DistributionsLead Time DistributionsLead Time Distributionssd = 15

sLT = 26

+sLT 26

75Demand for day 1

sd = 15

+225

75Demand for day 2

225Demand for

three-day lead timesd = 15

=15,75 == dd σLT

LTd ⋅=DemandMean

75Demand for day 3

LTdLT σσ =

Leadtime Demand DistributionLeadtime Demand DistributionLeadtime Demand DistributionLeadtime Demand Distribution

Cycle-service level y

Probability of stockout

A erage Average demand

during l d ilead time

SS

ROP

LTzSS σ⋅=

Setting the Reorder Point• Reorder point (ROP) = Expected demand

during lead time ( ) + safety stock LTd ⋅g ( ) y(SS = )

dLTzz dLT ⋅⋅=⋅ σσ

• For find specific values of z based on your o d spec c va ues o based o you target service level, lookup Table B in your textbook appendix (pp 883)textbook appendix (pp. 883)

11-61

Setting the Reorder Point - ExampleLeadtime ( ) = 5 daysAverage daily demand ( ) = 20 units, d

LT5.4=dσg y ( )

Target service level = 95% (5% risk of stock out)Find Reorder Point and amount of safety stock

d

Find Reorder Point and amount of safety stock

F T bl A 1 64From Table A, z = 1.64

11-62

Appendix B

11-63

Ad i i i f h SAdministration of the System• Using the perpetual counting system, a signal is Using the perpetual counting system, a signal is

given when the records indicate that the inventory reaches the ROPreaches the ROP

• A two-bin system could be usedtwo bins of inventory– two bins of inventory

– bin A holds an amount equal to the reorder pointbin B holds the remainder of the order– bin B holds the remainder of the order

– customers are supplied out of bin Bh bi B i t it i ti t d– when bin B is empty, it is time to reorder

– customers are then supplied out of bin A until the order arrives

11-64

arrives

Ch t 12 Chapter 12 Inventory Management

• Discussion questions–1, 3, 4, 6, 9, 11, 12, 14S l d bl• Solved problem–1 2 3 41, 2, 3, 4

• Assigned problems- 3, 9, 14, 28(omit c,d)

11-65