SS02: Simulation of Inventory Policy of a Single Product

Problem Statement

A dealer of industrial appliances has a certain product and is interested in having an inventory
policy with two parameters, the reorder-level and the reorder quantity. The probability
distribution of demand per day and the probability distribution of the lead-time, developed by
past records are as shown in the following Table 1 and Table 2. Consider the initial inventory 35.
The different costs involved in the inventory are shown in Table 3.

Table 1 Probability of demand

Demand 4 5 6 7 8
Probability 0.15 0.2 0.3 0.21 0.14

Table 2 Probability of lead time

Lead Time (day) 1 2 3 4
Probability 0.2 0.3 0.35 0.15

Table 3 Costs involved in inventory

Holding Cost Shortage Cost Unit Cost Setup Cost
(per unit per day) (per unit per day) (per unit) (per order)
3 1 5 15
Objectives:

1. Prepare a 30 days’ simulation model of the inventory status by using Excel spreadsheet.
2. Perform 10 replications for the simulation to find the average inventory costs.
3. Find the optimum the reorder level and the reorder quantity.

Procedures

1. Formulate the model on spreadsheet

 Transfer the data of inventory problem from Table 1, 2 and 3 onto a spreadsheet as
displayed in Fig. 1. Data cells are lightly shaded and variable cells are lightly shaded with
boarder to distinguish them from other cells.

 To enter a range name, first select the data and choose define name from formulas menu
and type a range name in the name box.
(A range name is a descriptive name given to a block of cells that immediately identifies what is
there. Details range name with their range used in the simulation is shown in Table 4.

 Use the equation given in the Table 5 into corresponding cells. Equations contain Excel
functions and the range name.
 Use the Copy command to copy them down the columns according to the directions
shown in Table 5. Using these equations, spreadsheet then records the simulation
results for 30 days which is referred as one complete replication.
 Figure 1 A spreadsheet model for a simulation of the inventory problem
Table 4 Range name and legends

Range Name Range Cells Legends

RN_D B4:B34 DE Demand
Demand C4:C34 Prob. Probability
OrderStatus D4:D34 Cum. Cumulative Probability
OrderReceived E4:E34 RN Random Number
IL F4:F34 OS Order Status
RN_LT G4:G34 OR Order Received
OrderingCost I4:I34 IL Inventory Level
HoldingCost J4:J34 LT Lead Time
ShortageCost K4:K34 OC Ordering Cost
TotalCost L4:L34 HC Holding Cost
HoldingCostPerUnit P10 SC Shortage Cost
ShortageCostPerUnit P11 TC Total Cost
UnitCost P12
SetuPCost P13
ReorderLevel T10
ReorderQuantity T11
InitialInventory T12
TotalOrderingCost I35
TotalHoldingCost J35
TotalShortageCost K35
TotalInventoryCost L35
 Table 5 Equations used in Fig. 1
Cells Equations/Formulas Copy To
P4 =SUM($O$4:O4) P6-P8
T4 =SUM($S$4:S4) T6-H8
B5 =RAND() B6-B34
C5 =IF(RN_D<$P$4,$N$4,IF(RN_D<$P$5,$N$5,IF(RN_D<$P$6,$N$6,IF(RN_D<$P$7,$N$7,IF(RN_D<$ D6-D34
P$8,$N$8,0)))))
D5 =IF(H4=1,"r",IF(H4>1,"w",0))
D6 =IF(OR(H5=1,H4=2),"r",IF(OR(H5>1,H4>2),"w",0))
D7 =IF(OR(H6=1,H5=2, H4=3),"r",IF(OR(H6>1,H5>2, H4>3),"w",0))
D8 =IF(OR(H7=1,H6=2, H5=3, H4=4),"r",IF(OR(H7>1,H6>2, H5>3, H4>4),"w",0)) D9-D34
E5 =IF(OrderStatus="r",ReorderQuantity,0) E6-E34
F4 =InitialInventory
F5 =F4-Demand+OrderReceived F6-F34
G5 =IF(AND(IL<ReorderLevel, OrderStatus<>"w"),RAND(),0) G6-G34
H4 =IF(RN_LT=0,0,IF(RN_LT< $H$5,1,IF(RN_LT<$H$6,2,IF(RN_LT<$H$7,3,IF(RN_LT<$H$8,4,))))) H5-H34
I4 =IF(RN_LT<>0,(SetupCost+OrderAmount*UnitCost),0) I5-I34
J4 =IF(IL>0, IL*HoldingCostPerUnit,0) J5-J34
K4 =IF(IL<0, ABS(IL)*ShortageCostPerUnit, 0) K5-K34
L4 =OrderingCost+HoldingCost+ShortageCost K5-K34
I35 =SUM(OrderingCost)
J35 =SUM(HoldingCost)
K35 =SUM(ShortageCost)
L35 =SUM(TotalCost)
O23 =TotalOrderingCost
P23 =TotalHoldingCost
Q23 =TotalShortageCost
R23 =TotalInventoryCost
O34 =AVERAGE(O23:O33) P34-R34

2. Repeat simulation results (10 replications)

Simulation results can be repeated as desired in each time. Excel will generate a new
sequence of random numbers so a new sequence of demand and lead time.

 Generate the data table as in Fig. 1 for 10 replications. This is done by entering
equation into the first row of data table (O23-R23) that refer to the output cells
of interest (I35-L35) in Fig. 1.

 Select the entire contents of the table (N23:R33) and choose data table from the
menu data>What-if Analysis>data table. Finally choose any blank cell (U23) for
the column input cell and click OK. Excel then recalculates the output cell in
columns O, P, Q and R for each row where any number is entered in rows of
column N.
  Use AVERAGE function to find the average of 10 replications for each value.

Findings

 Enter the different value of reorder level and reorder quantity and record the results
separately.
 Compare the results to find the optimum value of reorder level and reorder quantity.
 Extend the simulation for 20, 30, 40 replications and compare the results.

Advanced Practices

 Run the simulation for more days and more replications.

 Extend the simulation for variable reorder quantity.