Chapter 5 - SCM

CHAPTER 5 – INVENTORY MANAGEMENT
Faculty of International Economic Relations

University of Economics and Law
1 Het begint met een idee

CONTENTS
 Definition, Types, Purposes

 Inventory costs
 Inventory models
 Inventory issues
Vrije Universiteit Amsterdam

DEFINITION AND TYPES OF INVENTORY
 Inventory is supplies of goods and materials (incl. raw materials, work

in process, and finished goods) that are held by an organization.
 Types of inventory
o Cycle stock
o Safety stock
o In-transit stock
o Speculative stock

PURPOSES OF INVENTORY
 Be a buffer between different parts of the supply chain

 Allow for demands that are larger than expected or unexpected
 Allow for deliveries that are delayed
 Take advantage of price discounts on large orders
 Allow the purchase of items when the price is low
 Allow the purchase of scarce items
 Allow for seasonal operations
 Make full loads and reduce transport costs
 Cover for emergencies
 Be profitable when inflation is high

INVENTORY COSTS
 Carrying (holding) costs

o Obsolescence costs
o Inventory shrinkage
o Storage costs
o Handling costs
o Insurance, tax, interest
 Ordering costs
 Stock-out (shortage) costs

INVENTORY MODELS
 Single-period models: based on one-time purchasing decision

 Fixed-order quantity models (continuous system): inventory is
continuously tracked and an order is placed when the inventory
declines to a reorder point
 Fixed-time period models (periodic system): inventory is checked at
regular periodic intervals and an order is placed to raise the
inventory level to a specified threshold

FIXED-ORDER QUANTITY MODEL – EOQ MODEL
Assumptions
 Only one product involved
 A continuous, constant, and known rate of demand
 A constant and known lead time
 A constant purchase price, independent of the order quantity
 All demand is satisfied
 Inventory holding cost is based on average inventory
 A constant ordering cost
 Determine order quantity that the total cost (incl. purchase cost,
ordering cost, holding cost) is minimized

𝐷 𝑄
𝑇𝐶=𝐷𝐶 + 𝑆+ 𝐻
𝑄 2
𝑇𝐶: 𝑇𝑜𝑡𝑎𝑙𝑎𝑛𝑛𝑢𝑎𝑙𝑐𝑜𝑠𝑡
𝐷 : 𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑
𝐶 :𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑄:𝑂𝑟𝑑𝑒𝑟 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑆: 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔𝑐𝑜𝑠𝑡
∗
𝑄=
√
2 𝐷𝑆
h𝐶
𝐻 : 𝐴𝑛𝑛𝑢𝑎𝑙h𝑜𝑙𝑑𝑖𝑛𝑔𝑐𝑜𝑠𝑡 ,h𝐶

EOQ MODEL - EXAMPLE
Demand for a smartphone at a store is 75 units per month. The store

incurs a fixed order cost of $700 each time an order is placed. Each
smartphone costs the store $800 and the store has an annual holding
cost of 20 percent per unit. What is the optimal order size in each
replenishment?

Source: ASCM (2020)

LOT SIZING WITH MULTIPLE PRODUCTS/CUSTOMERS
1. Lots are ordered and delivered independently for each

product
2. Lots are ordered and delivered jointly for all k models
3. Lots are ordered and delivered jointly for a selected subset of
the products

LOTS ARE ORDERED AND DELIVERED INDEPENDENTLY
Annual demands for the three products are DL = 12,000 units, DM =
1,200 units, and DH = 120 units. Each model costs $500. A fixed
transportation cost of $4,000 is incurred each time an order is
delivered. For each model ordered and delivered on the same truck, an
additional fixed cost of $1,000 per model is incurred for receiving and
storage. Holding cost: 20 percent. Calculate the annual cost.

𝐷 𝐿 =12,000 / year
𝐷 𝑀 =12,000 / year
𝐷 𝐻 =120/ year
𝐶𝑜𝑚𝑚𝑜𝑛𝑜𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡 ,𝑆=$ 4,000

𝑃𝑟𝑜𝑑𝑢𝑐𝑡 −𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐 𝑜𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡 , 𝑠 𝐿 =𝑠 𝑀 =𝑠 𝐻 =$ 1,000
𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 ,h=0.2
𝑈𝑛𝑖𝑡 𝑐𝑜𝑠𝑡 , 𝐶 𝐿 =𝐶 𝑀 =𝐶 𝐻 =$ 500

Litepro Medpro Heavypro

Demand per year 12,000 1,200 120
Fixed cost/order $5,000 $5,000 $5,000
Optimal order size 1,095 346 110
Cycle inventory 548 173 55
Annual holding cost $54,772 $17,321 $5,477
Order frequency 11.0/year 3.5/year 1.1/year
Annual ordering cost $54,772 $17,321 $5,477
Average flow time 2.4 weeks 7.5 weeks 23.7 weeks
Annual cost $109,544 $34,642 $10,954
Total cost: $155,140

LOTS ARE ORDERED AND DELIVERED JOINTLY
A decision to aggregate and order all three models each time an order
is placed. Calculate the optimal lot size for each model and the annual
cost.

∗
𝑆 =𝑆+ 𝑠 𝐿 + 𝑠 𝑀 + 𝑠 𝐻
∗
𝑛=
√ 𝐷 𝐿 h𝐶 𝐿 +𝐷 𝑀 h𝐶 𝑀 +𝐷 𝐻 h𝐶 𝐻
2𝑆
∗
𝐴𝑛𝑛𝑢𝑎𝑙 𝑜𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡=𝑆∗ 𝑛∗

𝐷𝐿 h 𝐶 𝐿 𝐷𝑀 h 𝐶 𝑀 𝐷𝐻 h 𝐶 𝐻
𝐴𝑛𝑛𝑢𝑎𝑙 h𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑜𝑠𝑡= ∗
+ ∗
+ ∗
2𝑛 2𝑛 2𝑛


Demand per year (D) 12,000 1,200 120
Order frequency (n∗) 9.75/year 9.75/year 9.75/year
Optimal order size (D/n∗) 1,230 123 12.3
Cycle inventory 615 61.5 6.15
Annual holding cost $61,512 $6,151 $615

LOTS ARE ORDERED AND DELIVERED JOINTLY FOR A SELECTED SUBSET OF
THE PRODUCTS
A decision to order jointly, but to be selective about which models they

include in each order. Evaluate the ordering policy and costs.

THE PRODUCTS

THE PRODUCTS

Demand per year (D) 12,000 1,200 120
Order frequency (n∗) 11.47/year 5.74/year 2.29/year
Optimal order size (D/n∗) 1,046 209 52
Cycle inventory 523 104.5 26
Annual holding cost $52,307 $10,461 $2,615

EPQ MODEL
Assumptions
 Only one product involved
 Annual demand is known
 The usage rate is constant
 Usage occurs continually
 Production occurs periodically
 The production rate is constant
 Lead time is known and constant
 There are no quantity discounts

EPQ MODEL
Slope = Production
Slope = Production
rate p Slope= - usage rate u
rate p – usage rate u
𝐼 𝑚𝑎𝑥 𝐷
𝑇𝐶=𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 + 𝑆𝑒𝑡𝑢𝑝 𝑐𝑜𝑠𝑡 = 𝐻+ 𝑆
2 𝑄
EPQ MODEL – ECONOMIC PRODUCTION QUANTITY
𝑄=∗
𝑝
√ √
2 𝐷𝑆 𝑝
𝐻 𝑝−𝑢
𝐷 : 𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑
𝐼 𝑚𝑎𝑥 =
𝑄𝑝
𝑝
(𝑝 −𝑢)
𝑆: 𝑆𝑒𝑡𝑢𝑝 𝑐𝑜𝑠𝑡
𝐻 : 𝐻𝑜𝑙𝑑𝑖𝑛𝑔𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
𝑝: 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛𝑜𝑟 𝑑𝑒𝑙𝑖𝑣𝑒𝑟𝑦 𝑟𝑎𝑡𝑒
𝑢:𝑈𝑠𝑎𝑔𝑒 𝑟𝑎𝑡𝑒

EPQ MODEL - EXAMPLE
A toy manufacturer uses 48,000 rubber wheels per year for its
popular toy car series. The firm makes its own wheels, which it can
produce at a rate of 800 wheels per day. The toy cars are assembled
uniformly over entire year. Holding cost is $1 per wheel a year. Setup
costs for a production run of wheels is $45. The firm operates 240
days per year.
What is the optimal run size?

LITTLE’S LAW
The average amount of inventory in a system is proportional to the

time it takes for inventory to flow through the system
I = 𝐷× 𝑇

REORDER POINT
1. Receive an order quantity Q. 4. The cycle then repeats.
Number
of units
on hand Q Q Q
R
2. Start using them L L
up over time. 3. When inventory reaches
Time down to a level of R, place
the next Q sized order.
𝐶𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦 (𝑑𝑒𝑚𝑎𝑛𝑑∧𝑙𝑒𝑎𝑑𝑡𝑖𝑚𝑒): 𝑅𝑂𝑃=𝐷 × 𝐿

SAFETY STOCK
The amount of inventory carried in addition to the expected demand

to reduce risk of stock-out during lead time
Quantity
Expected demand
during lead time
ROP
Safety stock
LT Time

PRODUCT AVAILABILITY MEASUREMENT
 Product fill rate: a fraction of product demand satisfied

from product in inventory
 Order fill rate: a fraction of orders filled from available
inventory
 Cycle service level: a fraction of replenishment cycles
ending with all the customer demand being met

CYCLE SERVICE LEVEL
The probability of not having a stock-out in a replenishment cycle
Service level
Risk of
Probability of a stock-out
no stockout
Expected ROP Quantity

demand Safety
stock
0 z z-scale

SAFETY STOCK
𝐷: 𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑑𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑

𝜎 𝐷 :𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝐿: 𝐿𝑒𝑎𝑑 𝑡𝑖𝑚𝑒
𝑠 𝐿 :𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑙𝑒𝑎𝑑𝑡𝑖𝑚𝑒
𝑧 :𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑓𝑜𝑟 𝑎 𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑒𝑑 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑙𝑒𝑣𝑒𝑙
𝜎 𝐿 : 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔𝑙𝑒𝑎𝑑𝑡𝑖𝑚𝑒
𝑅𝑂𝑃 =𝐷 𝐿 + 𝑠𝑠
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒: 𝐷 𝐿= 𝐷 × 𝐿
𝜎 𝐿= √ 𝐿𝜎 +𝐷 𝑠
2
𝐷
2 2
𝐿
𝑆𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘 :𝑠𝑠=𝑧 ×𝜎 𝐿

STANDARD NORMAL DISTRIBUTION
Z 0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09
0.0 0.5000 0.5040 0.5080 0.5120 0.5160 0.5199 0.5239 0.5279 0.5319 0.5359
0.1 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141
0.3 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
1.0 0.8413 0.8438 0.8461 0.8485 0.8508 0.8531 0.8554 0.8577 0.8599 0.8621
1.1 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830
1.2 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015
1.3 0.9032 0.9049 0.9066 0.9082 0.9099 0.9115 0.9131 0.9147 0.9162 0.9177
1.4 0.9192 0.9207 0.9222 0.9236 0.9251 0.9265 0.9279 0.9292 0.9306 0.9319
1.5 0.9332 0.9345 0.9357 0.9370 0.9382 0.9394 0.9406 0.9418 0.9429 0.9441
1.6 0.9452 0.9463 0.9474 0.9484 0.9495 0.9505 0.9515 0.9525 0.9535 0.9545
1.7 0.9554 0.9564 0.9573 0.9582 0.9591 0.9599 0.9608 0.9616 0.9625 0.9633
1.8 0.9641 0.9649 0.9656 0.9664 0.9671 0.9678 0.9686 0.9693 0.9699 0.9706
1.9 0.9713 0.9719 0.9726 0.9732 0.9738 0.9744 0.9750 0.9756 0.9761 0.9767

EXERCISE
Weekly demand for coke at a supermarket is normally distributed,

with a mean of 1,500 bottles and a standard deviation of 300. The
replenishment lead time is always two weeks. Assuming that a
continuous review policy is used, please calculate the safety stock
that the supermarket should carry to achieve a service level of 90
percent. What is the reorder point?

EXERCISE
Daily demand for computers at a shop is normally distributed, with a

mean of 500 and a standard deviation of 30. The computer supplier
takes an average of seven days to replenish inventory at the shop. The
shop’s manager wants a cycle service level of 90 percent. Determine
the safety inventory of computers if the standard deviation of the
lead time is two days.

FIXED-TIME PERIOD MODEL
𝑂𝑟𝑑𝑒𝑟 −𝑈𝑝 −𝑡𝑜 𝐿𝑒𝑣𝑒𝑙: 𝑂𝑈𝐿=𝐷 𝑇 + 𝐿 +𝑠𝑠

𝑀𝑒𝑎𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑇 +𝐿𝑝𝑒𝑟𝑖𝑜𝑑𝑠 , 𝐷𝑇 + 𝐿 =(𝑇 +𝐿)𝐷
𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑇 +𝐿 𝑝𝑒𝑟𝑖𝑜𝑑𝑠 , 𝜎 𝑇 + 𝐿 =√ 𝑇 + 𝐿𝜎 𝐷
𝑆𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘 :𝑠𝑠=𝑧 ×𝜎 𝑇 + 𝐿
𝑂𝑟𝑑𝑒𝑟 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦=𝑂𝑈𝐿−𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑜𝑛h𝑎𝑛𝑑
Weekly demand for coke at a supermarket is normally distributed, with a mean
of 1,500 bottles and a standard deviation of 300. The replenishment lead time
is two weeks. Assuming that an inventory review of every three weeks is
conducted, please calculate the safety stock that the supermarket should carry
to achieve a service level of 90 percent. What is the order-up-to level?

SINGLE-PERIOD MODEL
𝐶 o : 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑜𝑣𝑒𝑟𝑠𝑡𝑜𝑐𝑘𝑖𝑛𝑔𝑏𝑦 𝑜𝑛𝑒𝑢𝑛𝑖𝑡 , 𝐶 o =𝑐 − 𝑠

𝐶 𝑢 :𝐶𝑜𝑠𝑡 𝑜𝑓 𝑢𝑛𝑑𝑒𝑟𝑠𝑡𝑜𝑐𝑘𝑖𝑛𝑔𝑏𝑦 𝑜𝑛𝑒𝑢𝑛𝑖𝑡 , 𝐶 𝑢 =𝑝− 𝑐
𝑝: 𝑟𝑒𝑡𝑎𝑖𝑙𝑝𝑟𝑖𝑐𝑒𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑐:𝑢𝑛𝑖𝑡 𝑐𝑜𝑠𝑡
𝑠:𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
∗
𝑃 : 𝑡h𝑒𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑡h𝑎𝑡 𝑑𝑒𝑚𝑎𝑛𝑑 𝑤𝑖𝑙𝑙𝑏𝑒 𝑎𝑡 𝑜𝑟 𝑏𝑒𝑙𝑜𝑤𝑄
𝐶𝑢
𝑃 ( 𝑑𝑒𝑚𝑎𝑛𝑑 ≤𝑄 ) =
∗
𝐶𝑢+ 𝐶𝑜
∗
𝑂𝑝𝑡𝑖𝑚𝑎𝑙 𝑜𝑟𝑑𝑒𝑟 𝑠𝑖𝑧𝑒 :𝑄 =𝐷 + 𝑧 × 𝜎 𝐷

EXERCISE
A school organize a tournament game this month. Based on the past

experience the tournament organizer sells on average 1,500 T-shirts
with a standard deviation of 200. We make $10 on every shirt we sell
at the game, but lose $5 on every shirt not sold. How many shirts
should we make for the game?

ABC ANALYSIS OF INVENTORY
ABC inventory classification is to classify items into groups to establish

the appropriate control over each item.
 A items: 20% of items (making up 80% of annual dollar usage)
 B items: 40% of items (making up 15% of annual dollar usage)
 C items: 40% of items (making up 5% of annual dollar usage)
High
A
Annual
$ value
of items
B
Low C
Low High
Percentage of Items
ABC INVENTORY CLASSIFICATION
Annual Unit Cost Annual $ Usage

Part Number Annual $ Usage
Unit Usage ($) (%)
1 1,100 2 2,200 6%
2 600 40 24,000 63%
3 100 4 400 1%
4 1,300 1 1,300 3%
5 100 60 6,000 16%
6 10 25 250 1%
7 100 2 200 1%
8 1,500 2 3,000 8%
9 200 2 400 1%
10 500 1 500 1%
38,250

ABC INVENTORY CLASSIFICATION
Part Annual $ Cummulative $ Cummulative % Cummulative %

Annual $ Usage
Number Usage (%) Usage $ Usage of Items
2 24,000 63% 24,000 63% 10%
5 6,000 16% 30,000 78% 20%
8 3,000 8% 33,000 86% 30%
1 2,200 6% 35,200 92% 40%
4 1,300 3% 36,500 95% 50%
10 500 1% 37,000 97% 60%
3 400 1% 37,400 98% 70%
9 400 1% 37,800 99% 80%
6 250 1% 38,050 99% 90%
7 200 1% 38,250 100% 100%
Percentage Percentage of Value per

Classification
of Items $ Usage Class
A 20% 78% 30,000
B 40% 18% 7,000
C 40% 3% 1,250
Total 100% 100%

INVENTORY TURNOVER
The number of times that inventory is sold in a one-year period

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠𝑆𝑜𝑙𝑑
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

VENDOR-MANAGED INVENTORY (VMI)
An approach to inventory and order fulfilment whereby the supplier,

not the customer, is responsible for managing and replenishing
inventory
 Benefits:
o Improve the forecast
o Minimize the impact of demand amplification
o Minimize inventory, but meeting the service level

VENDOR-MANAGED INVENTORY (VMI)
 Approach:
o Agree a contract
o Share information
o Monitor the process
o Replenish inventory
o Payment
 Problems:
o Unwillingness to share data
o Investment and restructuring costs
o Retailer vulnerability
o Lack of standard procedures

SAFETY STOCK IN CENTRALIZED VS DECENTRALIZED SYSTEMS
𝐷𝑖 : 𝑀𝑒𝑎𝑛 𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝑑𝑒𝑚𝑎𝑛𝑑 𝑖𝑛𝑟𝑒𝑔𝑖𝑜𝑛𝑖,𝑖=1 ,…,𝑘

𝜎 𝑖 : 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝑑𝑒𝑚𝑎𝑛𝑑 𝑖𝑛𝑟𝑒𝑔𝑖𝑜𝑛𝑖,𝑖=1 ,…,𝑘
𝜌 𝑖𝑗 : 𝐶𝑜𝑟𝑟𝑒𝑙𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝑑𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑟 𝑟𝑒𝑔𝑖𝑜𝑛𝑠 𝑖, 𝑗 ,1 ≤ 𝑖≠ 𝑗 ≤ 𝑘
DECENTRALIZED OPTION
𝑘 𝑘
𝑇𝑜𝑡𝑎𝑙𝑠𝑎𝑓𝑒𝑡𝑦𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦𝑖𝑛𝑑𝑒𝑐𝑒𝑛𝑡𝑟𝑎𝑙𝑖𝑧𝑒𝑑𝑜𝑝𝑡𝑖𝑜𝑛=∑ 𝑧×𝜎𝐿 =∑ 𝑧×√ 𝐿×𝜎𝑖
𝑖
𝑖=1 𝑖=1
𝜎 𝐿 : 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒𝑖𝑛𝑟𝑒𝑔𝑖𝑜𝑛𝑖
𝑖

CENTRALIZED OPTION
𝜎 𝑖 : 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑖𝑛𝑟𝑒𝑔𝑖𝑜𝑛𝑖
j
𝑘
Meandemand at the centralizedregion: 𝐷 𝐶 =∑ 𝐷𝑖
𝑖=1
𝑘
𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑𝑎𝑡 𝑡h𝑒𝑐𝑒𝑛𝑡𝑟𝑎𝑙𝑧𝑖𝑒𝑑𝑟𝑒𝑔𝑖𝑜𝑛:𝑣𝑎𝑟 ( 𝐷 )=∑ 𝜎 +2∑ 𝜌𝑖𝑗 𝜎 𝑖 𝜎 𝑗
𝐶 2
𝑖
𝑖=1 𝑖> 𝑗
𝜎 𝐷 =√ 𝑣𝑎𝑟 ( 𝐷 )
𝐶 𝐶
𝐶
𝑆 𝑎𝑓𝑒𝑡𝑦 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑜𝑛 𝑎𝑔𝑔𝑟𝑒𝑔𝑎𝑡𝑖𝑜𝑛=𝑧 × √ 𝐿 × 𝜎 𝐷

CENTRALIZED OPTION (a special case)

𝐴𝑠𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛1: 𝐼𝑓 𝑎𝑙𝑙 𝑘𝑟𝑒𝑔𝑖𝑜𝑛𝑠 h𝑎𝑣𝑒𝑑𝑒𝑚𝑎𝑛𝑑 𝑡h𝑎𝑡 𝑖𝑠𝑖𝑛𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡 , 𝜌 𝑖𝑗 =0
𝐴𝑠𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛2: 𝐴𝑙𝑙𝑟𝑒𝑔𝑖𝑜𝑛𝑠 h𝑎𝑣𝑒𝑒𝑞𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑𝑠
𝐶
𝐷 =𝑘𝐷
𝜎 𝐷 =√ 𝑘 𝜎 𝐷
𝐶

EXERCISE
A car dealership has four outlets serving the entire and large province.
Weekly demand at each outlet is normally distributed, with a mean of 25
cars and a standard deviation of 5. The lead time for replenishment from
the manufacturer is 2 weeks. Each outlet covers a separate geographic area,
and the demand across any pair of areas is independent. The dealership is
considering the possibility of replacing the four outlets with a single large
outlet. Assume that the demand in the central outlet is the sum of the
demand across all four areas. The dealership is targeting a service level of
0.90. Compare the level of safety inventory needed in the two options.

RISK POOLING
Centralized option (aggregation) reduces the required safety

inventory — as long as the demand being aggregated is not perfectly
positively correlated (ρ=1).
Risk pooling: Demand variability is reduced if demand is aggregated

across locations  safety stock is reduced.

CHAPTER 5 – INVENTORY MANAGEMENT
THANK YOU!
48 Het begint met een idee

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CHAPTER 5 – INVENTORY MANAGEMENT

Faculty of International Economic Relations

1 Het begint met een idee

 Definition, Types, Purposes

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 Inventory is supplies of goods and materials (incl. raw materials, work

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 Be a buffer between different parts of the supply chain

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 Carrying (holding) costs

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 Single-period models: based on one-time purchasing decision

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Demand for a smartphone at a store is 75 units per month. The store

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Source: ASCM (2020)

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1. Lots are ordered and delivered independently for each

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Annual demands for the three products are DL = 12,000 units, DM =

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𝐶𝑜𝑚𝑚𝑜𝑛𝑜𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡 ,𝑆=$ 4,000

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Litepro Medpro Heavypro

Total cost: $155,140

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𝐴𝑛𝑛𝑢𝑎𝑙 𝑜𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡=𝑆∗ 𝑛∗

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Litepro Medpro Heavypro

Total cost: $136,558

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A decision to order jointly, but to be selective about which models they

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Litepro Medpro Heavypro

Total cost: $130,767

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The average amount of inventory in a system is proportional to the

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1. Receive an order quantity Q. 4. The cycle then repeats.

𝐶𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦 (𝑑𝑒𝑚𝑎𝑛𝑑∧𝑙𝑒𝑎𝑑𝑡𝑖𝑚𝑒): 𝑅𝑂𝑃=𝐷 × 𝐿

The amount of inventory carried in addition to the expected demand

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 Product fill rate: a fraction of product demand satisfied

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The probability of not having a stock-out in a replenishment cycle

Expected ROP Quantity

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𝐷: 𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑑𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑

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Weekly demand for coke at a supermarket is normally distributed,

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Daily demand for computers at a shop is normally distributed, with a

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𝑂𝑟𝑑𝑒𝑟 −𝑈𝑝 −𝑡𝑜 𝐿𝑒𝑣𝑒𝑙: 𝑂𝑈𝐿=𝐷 𝑇 + 𝐿 +𝑠𝑠

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