part ii, logistics and scm
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Outsourcing and strategic allianceOutline Difference between bid purchase(ReqForQt, CBE) and JIT purchase Role and benefits of outsourcing and purchases Risk of outsourcing Impact of internet on outsourcing
Procurement strategyFor bid purchasing, component/ products should be standardized to the
extend possible, drawings must be freezed, detailed bid documentsmust be prepared, and many suppliers should take part whichrequire extended advertising. JIT purchasing, on the contrary rely on
long relationship with few suppliers, few documents for the processof coordination and pricing, supplier evaluation process andstanding orders for flexible volumes to adjust to forecasts anddemands.
August 2010 2Prof. S. N. Varma
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Role of outsourcing and purchase
Outsourcing is becoming an important strategy for conventional as wellas JIT manufacturers for reducing cost of product from 90 s . It isspecially useful for rapidly changing technology and obsolescence inproducts. Some of the motivations for outsourcing are:
1. Economies of scale- suppliers aggregate demands for this economy2. Risk pooling- demand uncertainty transferred to supplier who pool risk
3. Reduce capital Investment of buyer, supplier share it with many buyers4. Focus on core competency5. Increased flexibility - ability to better react to customer demands
- ability to reduce product development time-ability to gain access to new technologies
August 2010 3Prof. S. N. Varma
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Risk of outsourcing
IBM had outsourced chip to Intel and Disk Operating System (DOS) to
Microsoft and lost major opportunitiesTwo substantial risks are:1. Loss of competitive knowledge and insights to cross functional team2. Conflictive objectives. Transferring demand uncertainty is difficult in
case of decreasing demands. Design changes have also to be
coordinated.Fine and Whitney classify reasons for outsourcing into two category:1. Dependency on capacity- the buying firm has knowledge and skill to
produce component but still it outsource for cost reduction2. Dependency on knowledge- buying firm do not have core competency
August 2010 4Prof. S. N. Varma
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Two types of products:
Two types of products:1. Modular Product - components are independent of each other
- components are interchangeable- standard interfaces are used- a component can be changed independently
- customer preference determine product configuration2. Integral Product - cant be made from off the shelf components
- components perform multiple functions- designed as single system, top-down design- evaluated as single system performance
In real life very few products are truly modular or integral. However mostproducts can be put between the continuum of truly modular productlike a Computer and integral product like an airplane
August 2010 5Prof. S. N. Varma
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Framework for make/Buy decisions
Type of Product Dependency onknowledge andcapacity
Independent forknowledge,dependency forcapacity
Independent forknowledge andcapacity
Modular Outsourcing is Risky Outsourcing is anopportunity
Opportunity toreduce cost throughoutsourcing
Integral Outsourcing is veryRisky
Outsourcing isoption
Keep productionInternal
August 2010 6Prof. S. N. Varma
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Cost and risk tradeoff in purchasing A portfolio approach based on cost-risk trade off can use three types of
approaches for purchasing1. Base commitment level- for a minimum volume at an agreed low cost2. Flexible Option level-buyer pays small cost upfront in return for a
commitment to get supply up to a level paying additional for more. Inthis case total cost is higher than the base commitment level cost.
3. Spot purchasing- normally for additional supplies and competition.
August 2010 7Prof. S. N. Varma
QuantityOption Levels
High Inventory Riskto supplier
Do not Apply
Low Price and
Shortage Risk toBuyer
Inventory Risk
to buyer
Low High
Quantity Base Commitment level
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12
InventoryManagement
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Learning Objectives
Define the term inventory and list the major reasons for holding inventories; and list themain requirements for effective inventory
management. Discuss the nature and importance of service
inventories Discuss periodic and perpetual review
systems. Discuss the objectives of inventory
management.
Describe the A-B-C approach and explain how
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Learning Objectives
Describe the basic EOQ model and its assumptions and solvetypical problems.
Describe the economic production quantity model and solvetypical problems.
Describe the quantity discount model and solve typical problems. Describe reorder point models and solve typical problems. Describe situations in which the single-period model would be
appropriate, and solve typical problems.
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Independent Demand
A
B(4) C(2)
D(2) E(1) D(3) F(2)
Dependent Demand
Independent demand is uncertain.
Dependent demand is certain.
Inventory : a stock or store of goods
Inventory
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Inventory Models
Independent demand finished goods, items that are ready to besold E.g. a computer
Dependent demand components of finished products
E.g. parts that make up the computer
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Types of Inventories
Raw materials & purchased parts Partially completed goods called
work in progress
Finished-goods inventories (manufacturing firms )
or merchandise(retail stores )
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Types of Inventories (Contd)
Replacement parts, tools, & supplies
Goods-in-transit to warehouses or customers
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Functions of Inventory
To meet anticipated demand
To smooth production requirements
To decouple operations
To protect against stock-outs
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Functions of Inventory (Contd)
To take advantage of order cycles To help hedge against price increases
To permit operations
To take advantage of quantity discounts
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Objective of Inventory Control
To achieve satisfactory levels of customer service while keepinginventory costs within reasonable bounds
Level of customer service
Costs of ordering and carrying inventory
Inventory turnover is the ratio of average cost of goods sold toaverage inventory investment.
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A system to keep track of inventory
A reliable forecast of demand
Knowledge of lead times
Reasonable estimates of Holding costs
Ordering costs
Shortage costs
A classification system
Effective Inventory Management
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Inventory Counting Systems
Periodic System Physical count of items made at periodic intervals Perpetual Inventory System
System that keeps trackof removals from inventorycontinuously, thusmonitoringcurrent levels of
each item
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Inventory Counting Systems(Contd)
Two-Bin System - Two containers of inventory; reorder when thefirst is empty
Universal Bar Code - Bar codeprinted on a label that hasinformation about the itemto which it is attached
0
214800 232087768
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Lead time : time interval between ordering and receiving theorder
Holding (carrying) costs : cost to carry an item in inventory for alength of time, usually a year
Ordering costs : costs of ordering and receiving inventory
Shortage costs : costs when demand exceeds supply
Key Inventory Terms
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ABC Classification System
Classifying inventory according to some measure of importanceand allocating control efforts accordingly.
A - very important
B - mod. importantC - least important
Figure 12.1
Annual$ valueof items
A
B
C
High
Low
Low High
Percentage of Items
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Cycle Counting
A physical count of items in inventory
Cycle counting management
How much accuracy is needed?
When should cycle counting be performed?
Who should do it?
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Economic order quantity (EOQ) model The order size that minimizes total annual cost
Economic production model
Quantity discount model
Economic Order Quantity Models
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Only one product is involved Annual demand requirements known
Demand is even throughout the year
Lead time does not vary
Each order is received in a single delivery
There are no quantity discounts
Assumptions of EOQ Model
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The Inventory Cycle Figure 12.2
Profile of Inventory Level Over Time
Quantityon hand
Q
Receiveorder
Placeorder
Receiveorder
Placeorder
Receiveorder
Lead time
Reorderpoint
Usagerate
Time
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Total Cost
Annualcarryingcost
Annualorderingcost
Total cost = +
TC = Q2
H DQ
S+
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Cost Minimization Goal
Order Quantity (Q)
The Total-Cost Curve is U-Shaped
Ordering Costs
Q O
A n n u a l C o s t
(optimal order quantity)
TC Q
H D
QS
2
Figure 12.4C
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Deriving the EOQ
Using calculus, we take the derivative of the total cost function andset the derivative (slope) equal to zero and solve for Q.
Q =2DS
H=
2(Annual Demand )(Order or Setup Cost ) Annual Holding CostOPT
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Minimum Total Cost
The total cost curve reaches its minimum where the carrying andordering costs are equal.
Q2
H DQ
S=
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Production done in batches or lots Capacity to produce a part exceeds the parts usage or demand
rate Assumptions of EPQ are similar to EOQ except orders are
received incrementally during production
Economic Production Quantity (EPQ)
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Only one item is involved Annual demand is known Usage rate is constant Usage occurs continually
Production rate is constant Lead time does not vary No quantity discounts
Economic Production Quantity Assumptions
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Economic Run Size
QDS H
p p u0
2
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Total Costs with Purchasing Cost
Annualcarryingcost
PurchasingcostTC = +
Q2
H DQ
STC = +
+Annualorderingcost
PD +
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Total Costs with PD
C o s t
EOQ
TC with PD
TC without PD
PD
0 Quantity
Adding Purchasing costdoesnt change EOQ
Figure 12.7
T l C i h C C i
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Total Cost with Constant CarryingCosts
OC
EOQ Quantity
T o t a
l C o s t
TCa
TCc
TCbDecreasing
Price
CCa,b,c
Figure 12.9
When to Reorder with EOQ
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When to Reorder with EOQOrdering
Reorder Point - When the quantity on hand of an item drops tothis amount, the item is reordered
Safety Stock - Stock that is held in excess of expected demanddue to variable demand rate and/or lead time.
Service Level - Probability that demand will not exceed supplyduring lead time.
Determinants of the Reorder
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Determinants of the Reorder Point
The rate of demand The lead time Demand and/or lead time variability Stockout risk (safety stock)
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Safety Stock
LT Time
Expected demandduring lead time
Maximum probable demandduring lead time
ROP
Q u a n t i t y
Safety stock
Figure 12.12
Safety stock reduces risk of stockout during lead time
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Reorder Point
ROP
Risk of a stockout
Service level
Probability of no stockout
Expected
demand Safetystock
0 z
Quantity
z-scale
Figure 12.13
The ROP based on a normalDistribution of lead time demand
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Orders are placed at fixed time intervals Order quantity for next interval? Suppliers might encourage fixed intervals May require only periodic checks of inventory levels
Risk of stockout Fill rate the percentage of demand filled by the stock on hand
Fixed-Order-Interval Model
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Tight control of inventory items Items from same supplier may yield savings in:
Ordering Packing Shipping costs
May be practical when inventories cannot be closely monitored
Fixed-Interval Benefits
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Requires a larger safety stock Increases carrying cost Costs of periodic reviews
Fixed-Interval Disadvantages
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Single period model : model for ordering of perishables andother items with limited useful lives
Shortage cost : generally the unrealized profits per unit
Excess cost : difference between purchase cost and salvagevalue of items left over at the end of a period
Single Period Model
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Continuous stocking levels
Identifies optimal stocking levels
Optimal stocking level balances unit shortage and excess cost
Discrete stocking levels
Service levels are discrete rather than continuous
Desired service level is equaled or exceeded
Single Period Model
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Optimal Stocking Level
Service Level
So
Quantity
Ce Cs
Balance point
Service level = CsCs + Ce
Cs = Shortage cost per unitCe = Excess cost per unit
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Example 15
Ce = $0.20 per unit Cs = $0.60 per unit Service level = Cs/(Cs+Ce) = .6/(.6+.2) Service level = .75
Service Level = 75%
Quantity
Ce Cs
Stockout risk = 1.00 0.75 = 0.25
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Too much inventory Tends to hide problems Easier to live with problems than to eliminate them Costly to maintain
Wise strategy Reduce lot sizes Reduce safety stock
Operations Strategy
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Considerations in Inventory Systems
Type of customer demand
Planning time horizon
Replenishment lead time
Constraints and relevant costs
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Relevant Inventory Costs
Ordering costs
Receiving and inspections costs
Holding or carrying costs
Shortage costs
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Inventory Management Questions
What should be the order quantity (Q) ? When should an order be placed, called a reorder point (ROP )? How much safety stock (SS) should be maintained?
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Inventory Models
Economic Order Quantity (EOQ) Special Inventory Models
With Quantity Discounts
Planned Shortages Demand Uncertainty - Safety Stocks Inventory Control Systems
Continuous-Review (Q,r)
Periodic-Review (order-up-to) Single Period Inventory Model
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Inventory Levels For EOQ Model
0
U n
i t s o n
H a n d
Q
Q
D
Time
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Annual Costs For EOQ Model
0100200300400500600
700800900
A n n u a
l C o s
t , $
Order Quantity, Q
Holding Cost
Ordering Cost
Total Cost
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EOQ Formula
NotationD = demand in units per year H = holding cost in dollars/unit/year
S = cost of placing an order in dollarsQ = order quantity in units Total Annual Cost for Purchase Lots
EOQ TCp S D Q H Q ( / ) ( / )2
EOQ DS H
2
A l C f Q i Di
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Annual Costs for Quantity Discount Model
0 100 200 300 400 500 600 700
22,000
21000
20000
2000
1000
C = $20.00 C = $19.50 C = $18.75
Order quantity, Q
I L l F Pl d Sh
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Inventory Levels For Planned ShortagesModel
Q
Q-K
0
-K T1 T2
TIME
T
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Formulas for Special Models
Quantity Discount Total Cost Model
Model with Planned ShortagesTC CD S D Q I CQqd ( / ) ( / )2
TC S DQ
H Q K
QB
K Qb
( )2 2
2 2
Q DS H
H B B
*
2
K Q H
H B* *
V l f Q* d K* A
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Values for Q* and K* as AFunction of Backorder Cost
B Q* K* Inventory Levels
B
0 B
B 0
2 DS
H
2 DS H
H B B
undefined
Q H
H B*
Q*
0 0
0
0
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Demand During Lead Time Example
+ + + =
u=3
15.
u=3 u=3 u=3
15. 15.
L 3
d L
12 ROP
s s
Four Days Lead Time Demand During Lead time
15.
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Safety Stock (SS)
Demand During Lead Time (LT) has Normal Distribution with--
SS with r% service level
Reorder Point Mean d LT L( ) ( ) Std Dev LT L. .( )
SS z LT r
ROP SS d L
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Continuous Review System (Q,r)
Average lead time usage, d L
Reorder point, ROP
Safety stock, SS
Inventory on hand
EOQ
EOQ
d1d2
d3
Amount used during first lead time
First leadtime, LT 1
Order 1 placed
LT 2 LT 3
Order 2 placed Order 3 placed
Shipment 1 received Shipment 2 received Shipment 3 received
Time
Periodic Review System
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Periodic Review System(order-up-to)
RP RP RP
Review period
First order quantity, Q1
d1
Q2 Q3
d2
d3
Target inventory level, TIL
Amount used duringfirst lead time
Safety stock, SS First lead time, LT 1 LT 2 LT 3
Order 1 placed Order 2 placed Order 3 placed
Shipment 1 received Shipment 2 received Shipment 3 received
Time
Inventory on Hand
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Inventory Control Systems
Continuous Review System
Periodic Review System
EOQ DS H
ROP SS LT SS z LT r
2
RP EOQTIL SS RP LT
SS z RP LT r
/ ( )
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ABC Classification of Inventory Items
0102030405060708090
100110
P e r c e n t a g e o
f d o l l a r v o
l u m e
Percentage of inventory items (SKUs)
A B C
In entor Items Listed in Descending Order
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Inventory Items Listed in Descending Order of Dollar Volume
Monthly Percent of Unit cost Sales Dollar Dollar Percent of
Inventory Item ($) (units) Volume ($) Volume SKUs Class
Computers 3000 50 150,000 74 20 A
Entertainment center 2500 30 75,000
Television sets 400 60 24,000Refrigerators 1000 15 15,000 16 30 BMonitors 200 50 10,000
Stereos 150 60 9,000Cameras 200 40 8,000Software 50 100 5,000 10 50 CComputer disks 5 1000 5,000CDs 20 200 4,000
Totals 305,000 100 100
Single Period In entor Model
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Single Period Inventory Model Newsvendor Problem Example
D = newspapers demandedp(D) = probability of demand
Q = newspapers stockedP = selling price of newspaper, $10C = cost of newspaper, $4
S = salvage value of newspaper, $2Cu = unit contribution: P-C = $6Co = unit loss: C-S = $2
Single Period Inventory Model
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Single Period Inventory Model Expected Value Analysis
Stock Qp(D) D 6 7 8 9 10
.028 2 4 2 0 -2 -4
.055 3 12 10 8 6 4
.083 4 20 18 16 14 12
.111 5 28 26 24 22 20
.139 6 36 34 32 30 28
.167 7 36 42 40 38 36
.139 8 36 42 48 46 44
.111 9 36 42 48 54 52
.083 10 36 42 48 54 60
.055 11 36 42 48 54 60
.028 12 36 42 48 54 60
Expected Profit $31.54 $34.43 $35.77 $35.99 $35.33
Single Period Inventory Model
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Single Period Inventory Model Incremental Analysis
E (revenue on last sale) E (loss on last sale)
P ( revenue) (unit revenue) P (loss) (unit loss)
P D Q C P D Q C u o( ) ( )
1 P D Q C P D Q C u o( ) ( )
P D QC
C C
u
u o
( ) (Critical Fractile)
where:Cu = unit contribution from newspaper sale ( opportunity cost of underestimating demand)Co = unit loss from not selling newspaper (cost of overestimating demand)D = demandQ = newspaper stocked
Critical fractile for the newsvendor
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Critical fractile for the newsvendor problem
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
P r o
b a
b i l i t y
Newspaper demand, Q
P(DQ)
(Cu applies )
0.722
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Retail Discounting Model
S = current selling price D = discount price P = profit margin on cost (% markup as decimal)
Y = average number of years to sell entire stock of dogs atcurrent price (total years to clear stock divided by 2) N = inventory turns (number of times stock turns in one year)
Loss per item = Gain from revenue
S D = D(PNY)
)1( PNY S
D
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Topics for Discussion
Discuss the functions of inventory for differentorganizations in the supply chain.
How would one find values for inventory costs? How can information technology create a competitive
advantage through inventory management? How valid are the assumptions for the EOQ model? How is a service level determined for inventory items? What inventory model would apply to service capacity
such as seats on an aircraft?
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Interactive Exercise
The class engages in an estimation of the cost of a 12-ounce serving of Cokein various situations (e.g., supermarket, convenience store, fast-foodrestaurant, sit-down restaurant, and ballpark). What explains thedifferences?
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Role of Inventory in Services
Decoupling inventories Seasonal inventories Speculative inventories Cyclical inventories
In-transit inventories Safety stocks
top related