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Spyros Reveliotis

In this document, we shall use the results developed for the (Q, r) inventory

control policy in order to show that the substitution of a centralized inventory system for a given product by n more locally operated inventory systems with the same

cost structure and fill rate level and facing independent regional demands, will increase the total safety stock maintained across these local inventory systems by a

So, first consider the n local inventory systems, each serving the demand of

a certain region. These regions are non-overlapping, and each of these inventory

systems experience the same ordering and holding costs, A and h, and the same

replenishment lead time, l. They are also operated at the same fill rate level a, and

they experience the same type of demand. In particular, for the reasons discussed

in class, we shall assume that regional demands over a replenishment interval are

normally distributed, with mean l and st. deviation l (where the subscript l stands

for local).

Based on the above information, the safety stock carried by each of these local

inventory systems can be computed as follows:

First, it is reasonable to assume that the order size Ql for each of these systems

has been optimized according to the EOQ formula. More specifically, let Dl denote

the expected annual regional demand (for any of the considered n regions). Then,

r

2ADl

Ql =

(1)

hl

From the (approximating) formulae developed in class for the fill rate of a

(Q, r)-inventory system, we have:

S(Ql , rl ) = 1

1

1

[B(rl ) B(rl + Ql )] 1 B(rl ) = a

Ql

Ql

B(rl ) = (1 a)Ql .

(2)

Also, from the assumed normality of the lead-time demand, we have that

B(rl ) = l L(

rl l

)

l

(3)

where L() is the loss function for the standardized normal distribution. From

Eqs 2 and 3, we get:

rl l

) = (1 a)Ql

l

rl l

1a

L(

)=

Q

l

l l

rl l

1a

= L1 (

Q )

l

l l

l L(

(4)

l Ql ) denotes the inversion of the loss function L()

at the point 1a

l Ql defined by the values of a, l and Ql . From Eq. 4 we have that

the safety stock carried at each local inventory system is given by

ssl = rl l = l L1 (

1a

Q ),

l l

(5)

1

sstot

l = n ssl = n l L (

1a

Q ).

l l

(6)

Next, consider the substitution of the above distributed inventory system with

a centralized inventory operation with the same ordering and holding cost A and

h. This facility has also the same replenishment lead time l and it is operated at

the same target fill rate a. On the other hand, this facility faces the cumulative demand faced by the original n inventory systems, and therefore, its expected annual

demand is Dc = n Dl and its lead-time demand is normally distributed with mean

are obtained by (i) considering the lead-time demand for the centralized inventory

system as a random variable Xc defined by

Xc = Xl1 + . . . + Xln

(7)

where Xli is the (random) regional lead-time demand for region i = 1, . . . , n, and (ii)

further assuming that the regional demands Xli are mutually independent. Then,

E[Xc ] = E[Xl1 ] + . . . + E[Xln ]

Var[Xc ] =

Var[Xl1 ] + . . . +Var[Xln ]

(8)

(9)

From the above discussion we also have that an optimized selection for the

order size of the centralized inventory is

r

r

2ADc

2AnDl

=

= n Ql

(10)

Qc =

h

h

2

But then, the requirement for a target fill rate of a implies that

1

B(rc ) = a

Q

B(rc ) = (1 a)Qc

rc c

c L(

) = (1 a)Qc

c

rc c

1a

L(

)=

Q

c

c c

1a

rc c

)=

L(

nQl

c

nl

rc c

1a

L(

)=

Q

c

l l

1a

rc c

= L1 (

Q )

c

l l

1a

ssc = rc c = c L1 (

Q )

l l

1a

Q )

ssc = n l L1 (

l l

S(Qc , rc ) 1

(11)

sstot

l

= n

ssc

(12)

It is instructive to notice in the derivations of Eq. 11 how the final result of

Eq. 12 was shaped up by the established relations among the various corresponding

parameters of the two inventory systems. Also, consider how the above derivations

will be impacted by some correlation among the regional demands; e.g., how the

above analysis will be affected if the demands arising in (some of) these regions

are picking up or slowing down in sync?

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