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Inventory Management in Services

Service Industries Affected
‡ Retail
± Grocers ± Department Stores ± Clothing/Toys/Building Supplies/etc.

‡ Military
± Soldier¶s pack contents ± Tank contents

‡ Repair Services (Field Service)
± Kit management ± Repair facilities

‡ Wholesalers

Chapter 13 ± Inventory Management in Services

Successful Service Operations Management, 2006, Thomson

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Differences from Manufacturing
‡ ‡ ‡ ‡ ‡ ‡ ‡ Low setup costs Large number of SKU's Demand variance/mean ratio larger in services Constraints on number of SKU's Perishability - food items, seasonal goods Product substitutability Information accuracy
Successful Service Operations Management, 2006, Thomson 3 2

Chapter 13 ± Inventory Management in Services

2006.Business Environment Changes ‡ Technology ‡ Logistics ‡ Inventory policies have not kept up Chapter 13 ± Inventory Management in Services Successful Service Operations Management. Thomson 4 .

2006.1: The Newsstand Buy papers for $0. sell for $0. Thomson 5 .50 Co = the cost of ³overage´ = $0.30 Cs = the cost of ³stocking out´ = $0.30=$0.30.20 Chapter 13 ± Inventory Management in Services Successful Service Operations Management.50-$0.Example 13.

2006. Thomson 6 .Newsstand Example Mean Demand = 90 Standard Deviation = 20 Chapter 13 ± Inventory Management in Services Successful Service Operations Management.

50 7 Successful Service Operations Management.60 <= P(d >= y).65 .70 . Thomson . so order 86 Demand (from lowest to highest) 82 85 86 88 90 Chapter 13 ± Inventory Management in Services P(demand >= amount in first column) .50= 0.55 . 2006.Marginal Analysis of the Newsstand increase inventory until: E(revenue of next unit of inventory) <= E(cost of next unit of inventory) Equation 13.60 .30/$0.1: Co /(Cs + Co) <= P(d >= y) $0.

2006.Marginal Analysis of the Newsstand Chapter 13 ± Inventory Management in Services Successful Service Operations Management. Thomson 8 .

2006.008= 99. weekly delivery Cs = $6.00-0.008 Stock to 1.25/52 = $0. Thomson 9 .Typical Retail Product Inventory Product sells for $10. Co = $10 x 0.05 Co /(Cs + Co) = 0.2% Asymmetric penalties force stocking levels even higher Chapter 13 ± Inventory Management in Services Successful Service Operations Management.

2006.Profit Curve for Typical Service Inventory Item Chapter 13 ± Inventory Management in Services Successful Service Operations Management. Thomson 10 .

variance = 10) Chapter 13 ± Inventory Management in Services Successful Service Operations Management.Negative Binomial Distribution (mean = 2. Thomson 11 . 2006.

Thomson 12 .Stocking Multiple Products ‡ Weeks of Demand or ³The Gut Feel´ Approach ‡ Using intuition regarding uncertainty ± Provide high service for items with less variance ± Provide lower service for items with high variance ‡ Using intuition regarding cost ± Provide high service for less costly items ± Provide lower service for more costly items Chapter 13 ± Inventory Management in Services Successful Service Operations Management. 2006.

Fill Rate Vs. Thomson 13 5 . Percent of Cycles with Stock-outs Important to customers: Fill Rate Typically calculated: Percent of Cycles Percent of Cycles with Stock-outs Calculation Calculating EOQ and Re-order Point Q = Sqrt(2xDemandxSetup cost/Holding cost) Re-order Point = Demand Lead Time + z x Standard Deviation of Demand Lead Chapter 13 ± Inventory Management in Services Time Successful Service Operations Management. 2006.

2006.6x100 +. Thomson 14 6 .Fill Rate Calculation 20% of days demand is 90 60% of days demand is 100 20% of days demand is 110 Stock = 90 Fill rate (.2x90 + .2x90 + .2x90 + .6x100 + .2x90)/(.6x100 +.2x110) = 90% Stock = 100 Fill rate (.2x100)/(.2x90 + .2x110) = 98% Chapter 13 ± Inventory Management in Services Successful Service Operations Management.6x90 + .

Cycle Service Vs. 2006. Thomson 15 . Fill Rate Inventory 110 Percent cycles with no stockout 20% 100% Fill rate 100% 90% 98% 80% 90 100 Chapter 13 ± Inventory Management in Services Successful Service Operations Management.

Thomson 16 . 2006.Methods to Stock Products ‡ Method 1: Weeks of Sales or ³The Gut Feel´ Approach ‡ Method 2: Constant ³K´ Solution or The ³Faulty Assumptions´ Approach ‡ Method 3: Constant Service Solution or The ³Logical but Not So Simple´ Approach ‡ Method 4: Optimal Solution ± Marginal Analysis Chapter 13 ± Inventory Management in Services Successful Service Operations Management.

2006. ± How much do you stock? Chapter 13 ± Inventory Management in Services Successful Service Operations Management. Thomson 17 9 . mean demand 9. mean demand 9. variance 81 ± item Byno-meal is Binomial distributed. variance 9 ± item Nega-Byno-meal is Negative Binomial distributed. variance 4 ‡ Desire a 95% service level (fill rate). mean demand 9.Effect of Differential Demand Variance on stocking methods ‡ Example: 3 items in inventory ± item PyZen is Poisson distributed.

2006. Thomson 18 . for each product Chapter 13 ± Inventory Management in Services Successful Service Operations Management.Method 1: Weeks of Sales Approach Stock two weeks worth of demand. or 18.

65 x 2 = 12.Method 2: Constant ³K´ Solution K=1.65 (as 1. For this specific case. Chapter 13 ± Inventory Management in Services Successful Service Operations Management.65 x 3 = 14. the calculations are: Byno-Meal: 9 + 1. 2006.65 is the ³K´ factor associated with 95% service) x standard deviation of demand units of safety stock in addition to mean demand.65 x 9 = 24. Thomson 19 . PyZen: 9 + 1. Nega-Byno-Meal: 9 + 1.

Thomson 20 . then achieve 95% service in each and every product Stock: 10 Byno-Meal 11 PyZen 27 Byno-Meal Where do these numbers come from? Chapter 13 ± Inventory Management in Services Successful Service Operations Management. 2006.Method 3: Constant Service Solution If 95% service is desired in the entire store.

Method 3: Constant Service Solution Chapter 13 ± Inventory Management in Services Successful Service Operations Management. 2006. Thomson 21 .

Thomson 22 . 2006.Method 4: Optimal Solution ± Marginal Analysis Stock: 12 Byno-Meal 13 PyZen 19 Byno-Meal Where do these numbers come from? Chapter 13 ± Inventory Management in Services Successful Service Operations Management.

92 Expected Customers Served Per Dollar 0. Where to assign 1st unit? Item Current Inventory 0 0 0 Cost Expected Customers Served by Next Unit 1. 2006. Assume assigned to P Chapter 13 ± Inventory Management in Services Successful Service Operations Management. Thomson 23 .00092 B P N $1000 $1000 $1000 Assign 1st unit to either item B or P.00 0.001 0.Marginal Analysis Iteratively assign inventory to products.00 1.001 0.

00099 0.00092 B P N $1000 $1000 $1000 Assign 2nd unit to B Chapter 13 ± Inventory Management in Services Successful Service Operations Management.00 1. Thomson 24 .99-1.001 0.99 0. 2006.00=0.92 Expected Customers Served Per Dollar 0.Marginal Analysis Item Current Inventory 0 1 0 Cost Expected Customers Served by Next Unit 1.

2006.Marginal Analysis Skip ahead to 43rd unit.000124 0.000115 B P N $1000 $1000 $1000 Assign 43rd unit to N.718=0.7% Chapter 13 ± Inventory Management in Services Successful Service Operations Management. Current overall service level 94.906=0. Thomson 25 .124 8. Overall service level 94.115 Expected Customers Served Per Dollar 0.037 8.842-8.021-7.952=0.2% Item Current Inventory 12 12 19 Cost Expected Customers Served by Next Unit 8.000037 0.989-8.

2006.000037 0.842-8.989-8.952=0. Thomson 26 .952 / 9 = 99.8% Chapter 13 ± Inventory Management in Services Successful Service Operations Management. Overall service level 95.2% N: 7.000124 0.037 8.124 7.5% P: 8.129 Expected Customers Served Per Dollar 0.777=0.718=0.906 / 9 = 87. Finished Ending individual service levels: B: 8.000129 B P N $1000 $1000 $1000 Assign 44th unit to P.Marginal Analysis Item Current Inventory 12 12 18 Cost Expected Customers Served by Next Unit 8.2%.906-7.842 / 9 = 98.

Why Bother? WEEKS OF DEMAND SOLUTION CONSTANT "K" SOLUTION CONSTANT PROBABILITY SOLUTION OPTIMAL SOLUTION Chapter 13 ± Inventory Management in Services Successful Service Operations Management. 2006. Thomson Cost: Cost: Cost: Cost: $540 $500 $480 $440 27 .

Item Cost Demand/ Typical Week Solution 1 1 10 10 2 2 20 20 Constant "K" Solution 2 2 23 23 Constant Probability 2 2 11 11 Optimal Solution 0 2 6 14 28 1 2-11 12 13-22 $1000 $100 $1000 $100 Chapter 13 ± Inventory Management in Services Successful Service Operations Management. all with Poisson demand as shown ‡ Desire a 90% service level (fill rate). Thomson . 2006.Effect of Differential Item Cost (Profit) on Stocking Methods ‡ 22 items in inventory.

000 ‡ Constant ³K´ Solution ± Service Level: mean + 1. 100% items 13-22.000 ‡ Constant Probability Problem ± Service Level: as close to 90% on each item as possible Cost: $26. 60% items 12.dev. 90% items 2-11. overall 92% Cost: $22. 0% on item 1.000 ‡ Optimal Solution ± Service Level: roughly. ± overall service near 100% Cost: $50.. 2006.Solutions from Methods ‡ Stock Two Week's Demand ± Service Level: 90% on items 1-11.000 Chapter 13 ± Inventory Management in Services Successful Service Operations Management. overall near 100% Cost: $44. 100% on items 12-22.28*std. Thomson 29 .

63 0. Thomson 30 . 2006.00099 0.0099 1 2 12 13 $1000 $100 $1000 $100 Assign 1st unit to item 13 Chapter 13 ± Inventory Management in Services Successful Service Operations Management.Marginal Analysis Iteratively assign inventory to products.99 0. Where to assign 1st unit? Item Number Current Inventory 0 0 0 0 Cost Expected Customers Served by Next Unit 0.63 0.0063 0.00063 0.99 Expected Number Served Per Dollar 0.

63 0.00099 0.0098 1 2 12 13 $1000 $100 $1000 $100 Chapter 13 ± Inventory Management in Services Successful Service Operations Management.99=0.63 0.Where to assign 2nd unit? Item Number Current Inventory 0 0 0 1 Cost Expected Customers Served by Next Unit 0.0063 0.97-.00063 0.99 1. Thomson 31 . 2006.98 Expected Number Served Per Dollar 0.

13 Expected Number Served Per Dollar 0.88-4.63=.0013 1 2 12 13 $1000 $100 $1000 $100 Assign to item 2 Chapter 13 ± Inventory Management in Services Successful Service Operations Management. 2006.26 5. Thomson 32 .79-9.00093 0.89-.Marginal Analysis Where to assign 20th unit? Item Number Current Inventory 0 1 5 13 Cost Expected Customers Served by Next Unit 0.66=.63 .00063 0.95=.0026 0.93 9.

66=.00063 0.88-4.Marginal Analysis Where to assign 21st unit? Item Number Current Inventory 0 2 5 13 Cost Expected Customers Served by Next Unit 0.0013 1 2 12 13 $1000 $100 $1000 $100 Assign to item 13 Chapter 13 ± Inventory Management in Services Successful Service Operations Management.98-.79-9.93 9. Thomson 33 .95=.89=.13 Expected Number Served Per Dollar 0. 2006.63 .00093 0.09 5.00090 0.

000 on inventory for parts 1-22 Item Number 1 2-11 12 13-22 Cost $1000 $100 $1000 $100 Demand/Day 1 1 10 10 Percent of Dem. Thomson 34 . 2006. 1 1 10 10 Const. but don't spend more than x on inventory´ Example: spend $22. K 1 1 10 10 Optimal 0 2 6 14 Constant K solution. where K=0 Service Levels: Percentage of Demand / Constant K = 83% Marginal Analysis = 92% Chapter 13 ± Inventory Management in Services Successful Service Operations Management.Multiple Products with a Budget Constraint "Get as much service as possible.

IBM Computer repair: $30 Billion in 1990 Office equipment repair: $8 Billion in 1990 Xerox Spare Parts Inventory Machine Types Part Types Service Engineers Chapter 13 ± Inventory Management in Services 100 50.000 200.500 35 Successful Service Operations Management.Large Service Sector Inventory Systems Xerox.000 13.000 15. 2006. Thomson .000 IBM $4 Billion 1.

36% Central Regional District Field Chapter 13 ± Inventory Management in Services Xerox 2 5 74 27.000 36 .57% inventory value ± Middle .Multi-Echelon Structure Typical structure ± Central .000 Successful Service Operations Management.000 IBM (1989) 2 21 64 15. Thomson IBM(1990's) 1 5 90 15.7% ± Field . 2006.

65 = 1. Thomson 37 . Stock 1.Centralized vs. 2006.000) x 1. each facing demand for a product characterized by normal distribution with mean of 50. System variance: 20 x 100 = 2.000. Decentralized Inventory ‡ Variance of large system is sum of variances of small systems ± Vcentral = Vfield_1 + Vfield_2 + « ‡ Example: 20 field units.074 Chapter 13 ± Inventory Management in Services Successful Service Operations Management.340 ± Centralized ‡ System mean: 20 x 50 = 1.000 + Square root (2. variance of 100.65 = 67 Total inventory in system: 20 x 67 = 1. 95% of cycles should not have a stock-out ± Decentralized ‡ For each field unit stock up to 50 + Square root (100) x 1.000.

and Inventory Inaccuracy ‡ ‡ ‡ ‡ ‡ Revenue Sharing Markdown Money Phantom Stockouts Inventory Inaccuracy Shrinkage Chapter 13 ± Inventory Management in Services Successful Service Operations Management. 2006.Practical Methods to Reduce Stockouts. Shrinkage. Thomson 38 .

Chapter Summary ‡ Opportunity Knocks! Why? ± Improvements in technology and logistics ± lack of inventory system response ‡ Stocking decisions ± ANY system is better than "gut feel" ± You get what you pay for Chapter 13 ± Inventory Management in Services Successful Service Operations Management. Thomson 39 . 2006.