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Supply Chain Management

Inventory Management and Control

Indian Institute of Management
Lucknow

Fixed-Period (P) Systems

Orders placed at the end of a fixed period

Inventory counted only at end of period

Order brings inventory up to target level

Only relevant costs are ordering and holding

Lead times are known and constant

Items are independent from one another

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Fixed-Period (P) Systems
Target maximum (T)
Q4

On
On--hand inventory

Q2
P

Q1

Q3
P

P
Time
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Figure 11.9
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Fixed-Period (P) Example

3 jackets are back ordered
No jackets are in stock
It is time to place an order
Target value = 50
Order amount (Q) = Target (T) - OnOn-hand
inventory - Earlier orders not yet received +
Back orders
Q = 50 - 0 - 0 + 3 = 53 jackets

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Characteristics of Fixed-Period Systems

Inventory is only counted at each review period

May be scheduled at convenient times

Appropriate in routine situations

May result in stockstock-outs between periods

May require increased safety stock

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Planned Shortages with Backorders
Used when:
when:
•Shortages are not expensive

Car Showrooms

•Backordering is allowed

Furniture Shops

• Unit costs are high
• Wide product variety
Extreme Case is ‘make to order’

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Inventory level

Planned Shortages with Backorders
Usage rate

Order quantity
= Q (maximum
inventory
level)

Average
inventory on
hand
Q - So
2

Zero
inventory
So
T1

Q* =
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T2

2DS (H + Cbo)
H*C
H*
Cbo

Time

So =

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2DSH
Cbo*(H + Cbo)
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Planned Shortages with Backorders - Example
Demand for an item is constant at 4500 units a month
month.. Unit cost is
INR 200
200,, rere-order cost is INR 1000
1000,, holding cost is 24
24%
% per annum
and shortage cost for backorders is 48
48%
% per annum.
annum.
Find an optimal inventory policy for this item
item..

Q* =

2DS (H + Cbo)
H*C
H*
Cbo

So =

= 1837.1

= 612.4

T1 = (Q*-S0)/D = 8.2 days
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2DSH
Cbo*(H + Cbo)

T2 = S0/D = 4.1 days

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Customer Service Level
For multiple items on the same order
If all items on an order have the same service level,
what is the probability of filling the order complete?
The service level for multiple items is the combination
of the individual item service levels as follows:
SL = SL1 x SL2 x SL3 …x SLn
Suppose 3 items have the following service levels—
0.95, 0.89, and 0.92. The probability of filling the order
complete is:
SL = 0.95 x 0.89 x 0.92 = 0.78
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Multi-Echelon Inventories
Control the entire channel inventory levels, not just a
single echelon.
Warehouse
echelon

Warehouse
lead-time, LTw

S
Supplier

da
e
l
l
i
a
t
Re e, LT R
tim

W

R1

R2

d 1 , s d1

d 2 , sd 2

Warehouse
R3

End customer demand

How much stock here when
retailers also carry stock?

d 3 , sd 3

Retailer

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Push Inventory Control
Example
Three warehouses are used to supply 900 retail drugstores. Each
warehouse serves approximately 300 stores. A large purchase of clock
radios is made, where radios were to be a promotional item in the next
forecast period. The special buy will result in more stock than needed,
but the company expects to sell all stock eventually. Warehouses are to
have a 90% in-stock probability. All of the purchased radios are to be
allocated to the warehouses based on the anticipated demand levels at
each warehouse. Account is taken of the inventory already on hand. A
total of 5000 radios is purchased. The next purchase will be made in
one month. Further information is given in next slide.
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Push Inventory Control (Cont’d)

Warehouse
1
2
3

Current
stock
level,
units
400
350
0

Forecasted
demand,
units
2,300
1,400
900
4,600

Forecast
error (std.
dev.), units
100
55
20

How should the allocation to the warehouses be made?

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Push Inventory Control (Cont’d)
Solution
Warehouse
1
2
3
a2,428

Total
requirements
a
2,428
1,470
926
4,824

= 2,300 + 1.28(100)

Total requirements = Forecast + z(Forecast error)
where z@90% = 1.28. Therefore,
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Push Inventory Control (Cont’d)
(1)

(2)

(3)=
(4)
(5)=
Pro(4)+(3)
(1)- (2)
Total
Onration
Net
require- hand requireAlloof
Ware- ments, stock, ments, excess, cation,
house units
units
units
units
units
a
b
1
2,428
400 2,028
463
2,491
2
1,470
350 1,120
282
1,402
3
926
0
926
181
1,107
c
Total 4,824
4,074
926
5,000
aTotal

requirements less (quantity on hand + quantity on order – backorders)
bExcess purchase quantity times forecast for warehouse divided by total
forecast quantity. For example, (5,000 – 4,074) x 2,300/4,600 = 463
c5,000 – 4,074 = 926
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Multi-Echelon Inventories Example
Example
An item has the following cost characteristics. Item
values are CR=$10/unit and CW=$5/unit. Carrying cost
is I = 20%/year. Ordering costs are SR=$40/order and
SW=$75/order. Lead times are LTR=0.25 month and
LTW=0.5 months. In-stock probability for retailers and
warehouses is 90%. Monthly demand statistics are:

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Monthly
avg., units

Std. dev.,
units

Retailer 1

202.5

16.8

Retailer 2

100.5

15.6

Retailer 3

302.5

18.0

Combined

605.5

32.4

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Monthly Demand Statistic
January
February
March
April
May
June
July
August
September
October
November
December
Average
Std. Dev.
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Retailer 1
218
188
225
217
176
187
221
212
210
203
188
185
202.5
16.8

Retailer 2
101
87
123
101
95
97
93
131
76
101
87
114
100.5
15.6

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Retailer 3
268
296
321
312
301
294
285
305
289
303
324
332
302.5
18.0

Combined
587
571
669
630
572
578
599
648
575
607
599
631
605.5
32.4
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Example (Cont’d)
Solution
Based on reorder point inventory control, the retailers’
inventory statistics are
Retailer 1

Retailer 2

Retailer 3

Reorder qty, Q

312

220

381

Reorder point, ROP

61

35

87

Avg. inv., AIL

167

120

202

The warehouse echelon order quantity is

2DW SW
QW =
= 2(605.5x12)(75) = 1,043.98, or 1,044 units
0.20(5)
ICW

ROPW = dW xLTW + zsW LTW = 605.5(.5) +1.28(32.4) .5
= 332 units
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Multi-Echelon Inventories (Cont’d)
The warehouse echelon inventory is
QW
AILW =
+ zsW LTW
2
= 1,043.98 +1.28(32.4) 0.5
2
= 551.32. or 551units
The average warehouse inventory is the warehouse
echelon inventory less the retailers’ inventory, or 551
– 167 –120 – 202 = 62 units.
Rule When the total warehouse inventory (sum of
retailers’ inventory, inventory at the warehouse and on
order, and retailers’ orders less any inventory committed
to customers drops below 332 units, order 1,044 units.
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Supply Chain Example
Suppose that inventory is to be maintained on a
distributor’s shelf for an item whose demand is
forecasted to be d = 100 units per day and sd = 10 units
per day. Reorder point is the method of inventory
control. The supply channel is shown in the diagram.
Determine the average inventory to be held at the
distributor where we have:
I = 10%/year
S = $10/order
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C = $5/unit
P = 0.99 during lead time
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Supply Chain Example
Supplier

Processing time

X

p

= 1 , s 2p = 0 .1
Transport time

Inbound transport

X

i

No significant
inventory at pool
points and trucks

= 4 , s i2 = 1. 0

Outbound transport
Pool point

Transport time

X
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o

Distributor

= 2 , s o2 = 0 . 25

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Supply Chain Example (Cont’d)
Solution The reorder point inventory theory applies.
However, determining the statistics of the demandduring-lead-time distribution requires taking the leadtime for the entire channel into account.
Recall,
2
s' = LT(sd2 ) + d 2(sLT
)

where
2
= sp2 + si2 + so2
sLT
= 0.1 + 1.0 + 0.25
= 1.35 days
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Supply Chain Example (Cont’d)
Average lead time
LT = X p + X i + X o = 1+ 4 + 2 = 7 days

Now
s' = 7 x102 +1002 x1.35 = 14,200 =119.16 units

and
2(100)(10)
= 1208.3 units
(0.1/365)(5)
1208.3
Q*
'
+ z(s ) =
+ 2.33(119.16) = 882 units
AIL =
2
2
ROP = 978 units
Q*

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=

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Square Root Law of Inventory Consolidation
The amount of inventory (regular stock) at multiple stocking
points can be estimated by the square root law when

• Inventory control at each point is based on EOQ
principles

• There is an equal amount on inventory at each point
The square root law is:

IT = Ii n
where
IT = amount of inventory at one location
Ii = amount of inventory at each of n locations
n = number of stocking points
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Square Root Law (Cont’d)
Example Suppose that there is $1,000,000 of inventory at 3
stocking points for a total of $3,000,000. If it were all
consolidated into 1 location, we can expect:
IT = 1,000,000 3 = $1,732,051

If we wish to consolidate from 3 to 2 warehouses, the
level of inventory in each warehouse would be:
I
Ii = T = $1,732,051 = $1,224,745
1.41
2
For a total system inventory of n x I = 2 x $1,224,745 =
$2,449,490.
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Square Root Law (Cont’d)
More simply
n2
I2 = I1 n
1

where
I2 = system inventory in n2 locations
I1 = system inventory in n1 locations
n2 = no. of new locations
n1 = no. of previous locations
So,
2
I2 = 3,000,000
= 2,449,490
3
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Inventory-Throughput Curve
Example
Suppose two warehouses with 390,000 lb. and
770,000 lb. of throughput respectively are to be
consolidated into a single warehouse with 390,000 +
770,000 = 1,160,000 lb. of annual throughput. How
much inventory is likely to be in the single warehouse?
The inventory-throughput curve developed from the
company’s multiple warehouse stocks is shown in the
figure below.
Note Reading from the plot, the inventory in the
consolidated warehouse has dropped to 262,000 lb.
from 132,000 + 203,000 = 335,000 lb. in the two
warehouses.
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Inventory-Throughput Curve
Average inventory level, AIL (000 lb.)
i

450
400
350

AILi = 3.12Di0.628

300
262

250
203

200

150 132
100
Current
warehouse

50

Consolidated
warehouse

0
0
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200

400
600
800
1000
1200
1400
Annual warehouse throughput, Di (000 lb.)
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1600

1800
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Inventory Turnover Ratio
Annual sales
Turnover ratio =
Average inventory
A fruit grower stocks its dried fruit products in 12 warehouses
around the country. What is the turnover ratio for the
distribution system?
Warehouse
no.
1
2
3
4
5
6

Annual
Average
warehouse
inventory
throughput, $
level, $
21,136,032
2,217,790
16,174,988
2,196,364
78,559,012
9,510,027
17,102,486
2,085,246
88,228,672 11,443,489
40,884,400
5,293,539

TO ratio =
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Warehouse
no.
7
8
9
10
11
12
Totals

$425,295,236
= 9.7
$43,701,344
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Annual
warehouse
throughput, $
43,105,917
47,136,632
24,745,328
57,789,509
16,483,970
26,368,290
425,295,236

Average
inventory
level, $
6,542,079
5,722,640
2,641,138
6,403,076
1,991,016
2,719,330
43,701,344

$ are at cost
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Role of Inventory in the Supply Chain
Improve Matching of Supply
and Demand
Improved Forecasting
Reduce Material Flow Time
Reduce Waiting Time
Reduce Buffer Inventory

Economies of Scale

Supply / Demand
Variability

Seasonal
Variability

Cycle Inventory

Safety Inventory

Seasonal Inventory

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