Managing Economies of Scale in a Supply Chain: Cycle InventoryIndependent vs. Dependent Demand Independent Demand — Demand for the item not related to the demand of other items - can only be forecasted Finished product Dependent Demand = Derived demand can be computed ComponentWhat is Inventory? * Inventory is the stock of any item (or resource) used in an organization. These items can include: raw materials, finished products, component parts, supplies, and work-in-process + An inventory system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should beInventory Costs * Holding (or carrying) costs — Costs for storage, handling, insurance, etc. Ordering (or Replenishment) costs — Costs of someone placing an order, follow-up, transportation, receiving, etc. Shortage costs — Costs of lost profit, or lost customer, etc.Inventory Holding or Carrying Costs = Capital costs —- cost or opportunity cost of money tied up as inventory =" Inventory space or occupancy costs — rent or depreciation « Inventory service costs - staff, insurance = Inventory risk costs - Theft, security, damage, deterioration, obsolescenceInventory Profile (with no uncertainty) Cycle Inventory Inventory Q Time tOptimum Order Quantity (EOQ) Model Total Ann Cost = Ann Ord Cost + Ann Carr Cost D Q Some Re eunr moon TC = (5 x s) + (5 x nc) = Annual Demand (units p.a.) wo * * Bote ecrnerc. TC is minimum at Q*, where at Q (Rs per order) aTC DS he = Annual inventory carrying do = QF + ZT =0 cost per rupee per annum Cost per unit of the item 2DS (Rs per unit) a = |— he = Annual inventory AC carrying cost per unit per annum (Rs/unit p.a.) and TC* = V2DShC500 300 200 100 o ° Sensitivity of EOQ A re = PS 4 OE tany QTC = a + >T Also, 7C* = V2DShC WIC Ps ne “TC*” QV2DSRC 2V2DShC 2DS +2 hc = 730 Te * 2 Japs we 20 40 60 80 100 120 140 160 180 200 —ord Cost. —Carr Cost. —Te Q 3.2 Check: aoa: = 23 ,Q* = 60 and Q = 90 or 40, Te n=s[s+5 x2 = 10833Cycle Inventory Order, Lot or batch size is the quantity that a stage of a supply chain either produces or purchases at a time Cycle inventory is the average inventory in a supply chain due to either production or purchases in lot sizes that are larger than those demanded by the customer Q: Quantity in a lot or batch sizeCycle Inventory Cycle inventory is the average inventory in a supply chain due to either production or purchases in lot sizes that are larger than those demanded by the customer lotsize Q 2 2 average inventory (Average)Cycle inventory = Average flow time = average flow rate Average flow time _ cycle inventory _@ ears of cycle inventory annual demand 2D”Cycle Inventory * Lower cycle inventory has « Shorter average flow time = Lower working capital requirements = Lower inventory holding costs * Cycle inventory is held to " Take advantage of economies of scale = Reduce costs in the supply chainRole of Cycle Inventory ina Supply Chain Primary role of cycle inventory is to allow different stages to purchase product in lot sizes that minimize the sum of material, ordering, and holding costs Ideally, cycle inventory decisions should consider costs across the entire supply chain In practice, each stage generally makes its own supply chain decisions This increases total cycle inventory and total costs in the supply chainRole of Cycle Inventory ina Supply Chain * Economies of scale exploited in three typical situations = A fixed cost is incurred each time an order is placed or produced = The supplier offers price discounts based on the quantity purchased per lot = The supplier offers short-term price discounts or holds trade promotionsLot Sizing for a Single Product * The economic order quantity (EOQ) Optimal lot size, Oo = = * Optimal Total Cost, Tc” =/2Dshc * The optimal ordering frequency + D_ [DhC n =—~>=,—— QO 28 * Optimal Time Between Orders (T*) g’ _ [28 Optimal T* = — = | ——_ D DhCAggregating Multiple Products in a Single Order * Savings in transportation costs = Reduces fixed cost for each product = Lot size for each product can be reduced = Cycle inventory is reduced * Single delivery from multiple suppliers or single truck delivering to multiple retailers * Receiving and loading costs reducedLot Sizing with Multiple Products or Customers Ordering, transportation, and receiving costs grow with the variety of products or pickup points Lot sizes and ordering policy that minimize total cost D;:Annual demand for product / S: Order cost incurred each time an order is placed, independent of the variety of products in the order s;: Additional order cost incurred if product / is included in the orderLot Sizing with Multiple Products or Customers * Three approaches = Each product manager orders his or her model independently = The product managers jointly order every product in each lot = Product managers order jointly but not every order contains every product; that is, each lot contains a selected subset of the productsLots Ordered and Delivered Jointly S=S+>'s; ee =nS* D,h Annual holding cont Total annual cost = ares D, AC +ns* 2n [2 AC; * 2S