managing business process flows: ch 6 supply chain management managing the supply chain key to...

Managing Business Process Flows: Ch 6

Supply Chain Management Managing the Supply Chain Key to matching demand with supply Managing materials waiting time Cost and Benefits of inventory

Inventory Analysis: Economies of Scale (Ch 6) Palu Gear: Inventory management of a retailer: EOQ +

ROP Levers for improvement

1Copyright © 2013 Pearson Education Inc. publishing as Prentice Hall

Key Financial Indicators of Supply Chain Performance

Return on Assets Net Present Value … …

These are LAGGING indicators. What must the supply chain do to achieve this?


Accurately Matching Demand with Supply is the Key Challenge: Inventories

2008 Logistics costs (US economy)– Freight Transportation $864Billion– Inventory Expense $420 Billion– Administrative Expense $60 Billion– Logistics related activity 9.4% of GDP

Inventory = Working capital– Reduced inventory implies less working capital

Why do inventories arise?– Mismatch between demand and supply


Costs of not Matching Supply and Demand

Cost of overstocking – liquidation, obsolescence, holding

Cost of under-stocking – lost sales and resulting lost margin


Where is the Flow Time?

Buffer Operation

Waiting Processing


Flow Times in White Collar ProcessesSource: J. Blackburn

Industry Process AverageFlow Time

TheoreticalFlow Time

Flow TimeEfficiency

Life Insurance New PolicyApplication

72 hrs. 7 min. 0.16%

ConsumerPackaging

NewGraphicDesign

18 days 2 hrs. 0.14%

CommercialBank

ConsumerLoan

24 hrs. 34 min. 2.36%

Hospital PatientBilling

10 days 3 hrs. 3.75%

AutomobileManufacture

FinancialClosing

11 days 5 hrs 5.60%


Operational Flows

Throughput R

Inventory I

I = R T Flow time T = Inventory I / Throughput R

FLOW TIME T


Why do Buffers Build?Why hold Inventory?

Economies of scale– Fixed costs associated with batches– Quantity discounts– Trade Promotions

Uncertainty– Information Uncertainty– Supply/demand uncertainty

Seasonal Variability Strategic

– Flooding, availability

Cycle/Batch stock

Safety stock

Seasonal stock

Strategic stock


Cost of Inventory

Physical holding cost

(out-of-pocket) Financial holding cost

(opportunity cost) Low responsiveness

– to demand/market changes– to supply/quality changes

Holding cost


Annual jacket revenues at a Palü Gear retail store are roughly $1M. Palü jackets sell at an average retail price of $325, which represents a mark-up of 30% above what Palü Gear paid its manufacturer. Being a profit center, each store made its own inventory decisions and was supplied directly from the manufacturer by truck. A shipment up to a full truck load, which was about 1500 jackets, was charged a flat fee of $2,200. To exploit economies of scale, stores typically ordered full truck loads. (Palü’s cost of capital is approximately 20%.)

What order size would you recommend for a Palü store in current supply network?

retailermanufacturer

Palü Gear: Retail Inventory Management & Economies of Scale


Economies of Scale: Inventory Build-Up Diagram

R: Annual demand rate,

Q: Number of wind breakers per replenishment order

Number of orders per year = R/Q.

Average number of wind breakers in inventory = Q/2 .

Q

Time t

Inventory Profile:# of wind breakers in inventory over time.

Inventory

Q/2

“cycle stock”

-R = Demandrate


Palü Gear: evaluation of current policy of ordering 1500 units each time

1. What is average inventory I? I = Annual cost to hold one unit H = Annual cost to hold I =

2. How often do we order? Annual throughput R = # of orders per year = Annual order cost =

3. What is total cost? TC =

4. What happens if order size changes?


Find most economical order quantity: Spreadsheet for a Palü Gear retailer

Number of units Number ofper order/batch Batches per Annual Annual Annual

Q Year: R/Q Setup Cost Holding Cost Total Cost50 62 135,385$ 1,250$ 136,635$ 100 31 67,692$ 2,500$ 70,192$ 150 21 45,128$ 3,750$ 48,878$ 200 15 33,846$ 5,000$ 38,846$ 250 12 27,077$ 6,250$ 33,327$ 300 10 22,564$ 7,500$ 30,064$ 350 9 19,341$ 8,750$ 28,091$ 400 8 16,923$ 10,000$ 26,923$ 450 7 15,043$ 11,250$ 26,293$ 500 6 13,538$ 12,500$ 26,038$ 510 6 13,273$ 12,750$ 26,023$ 520 6 13,018$ 13,000$ 26,018$ 530 6 12,772$ 13,250$ 26,022$ 540 6 12,536$ 13,500$ 26,036$ 550 6 12,308$ 13,750$ 26,058$ 600 5 11,282$ 15,000$ 26,282$ 650 5 10,414$ 16,250$ 26,664$ 700 4 9,670$ 17,500$ 27,170$ 750 4 9,026$ 18,750$ 27,776$ 800 4 8,462$ 20,000$ 28,462$ 850 4 7,964$ 21,250$ 29,214$ 900 3 7,521$ 22,500$ 30,021$

1000 3 6,769$ 25,000$ 31,769$

$-

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

$160,000

0 100 200 300 400 500 600 700 800 900 1000

Order (batch) size Q

Setup Cost

Holding Cost

Total Cost


Accurate Response to Scale Economies: Economic Order Quantity EOQ

The order quantity that minimizes total supply chain cost is: H

SRQEOQ

2

H Q/2: Annual holding cost

Order Size Q

Total annual costs

S R /Q:Annual setup cost

SRH2

Annual unit demand

Fixed cost per order

Annual unit holding cost


Optimal Economies of Scale: For a Palü Gear retailer

R = 3077 units/ year = 59 units/wk C = $ 250 / unit

r = 0.20/year S = $ 2,200 / order

Unit annual holding cost = H = 0.20/yr x $250 = $50/yr

Optimal order quantity = Q = sqrt(2 x 3077 x 2200/50) = 520

Number of orders per year = R/Q = 5.9

Time between orders = Q/R = 0.17yr = 8.8weeks

Annual order cost = (R/Q)S = $13,008.87/yr

Average inventory I = Q/2 = 260

Annual holding cost = (Q/2)H =$13,008.87/yr

Average flow time T = I/R = 0.084 yr = 4.4weeks


Costs associated with batches

Order Costs (S)– Setup/Changeover of process– Transportation– Receiving

Holding costs (H)– Physical holding cost– Cost of capital– Cost of obsolescence


Optimal Economies of Scale: Managerial Insights

How cut inventories (economically smart)?

Budgeting for growth– Last FY: Sales = $100M Inventories = $20M– Next year: Sales = $200M Inventories = ?– Days-of-inventory:

Centralized inventory management

SRHCH

SRQ EOQEOQ 2

2


Learning Objectives: Batching & Economies of Scale

Increasing batch size Q of order (or production) increases average inventories (and thus flow times).

– Average inventory for a batch size of Q is Q/2.

The optimal batch size minimizes supply chain costs by trading off setup cost and holding cost and is given by the EOQ formula.

To reduce batch size, one must reduce setup cost (time). Economies of scale are manifested by the square-root

relationship between QEOQ and (R, S):– If demand increases by a factor of 4, it is optimal to increase batch size

by a factor of 2 and produce (order) twice as often.– To reduce batch size by a factor of 2, setup cost has to be reduced by a

factor of 4.


Role of Leadtime L: Palü Gear cont.

The lead time from when a Palü Gear retailer places an order to when the order is received is two weeks. If demand is stable as before, when should the retailer place an order?

Inventory Profile:

Two key decisions in inventory management are:– How much to order?– When to order?

Q

Time t

-R

Inventory


Continuous Review Policy: Ordering Decisions and the Re-order Point

ROP

L

R

Placeorder n

I(t)

Q Q

timeReceiveorder n

LPlace

order n+1Receive

order n+1Place

order n+2


ROP and Inventory position

ROP = L × R But if lead time L is greater than time between orders, there will be more

than one order outstanding Inventory position = Inventory level (On-hand inventory) + On-order

inventory


Order Policies

Continuous Review: Ability to monitor inventory continuously and take action

– Order fixed quantity whenever inventory position reaches re-order point Periodic Review: Monitor inventory periodically and take action

– Order sufficient quantities at periodic intervals (e.g., every Monday) to raise inventory position to a target level (order up to level or OUL),


Inventory Profile for a Periodic Review Policy: Example Ch 6

31

Q=1200 units

OUL = 1800

2

1200 unitsRecd.

Review Period Tr=2

OrderPlaced

OrderPlaced

OrderRecd.

L=1 week

1200 unitsRecd.

L=1 week

600 units

4

OrderRecd.

Inventory Position

On-hand inventory


Periodic Review: Palu Gear

OUL = (L+Tr) × R

Suppose Palu Gear placed orders 4 weeks; then Tr = 4 weeks

With L = 2 weeks, – OUL = (4+2) x 59 = 354 units.


Learning Objectives: Batching & Economies of Scale

Increasing batch size of production (or purchase) increases average inventories (and thus cycle times).

Average inventory for a batch size of Q is Q/2. The optimal batch size trades off setup cost and holding cost. To reduce batch size, one has to reduce setup cost (time). Square-root relationship between Q and (R, S):

– If demand increases by a factor of 4, it is optimal to increase batch size by a factor of 2 and produce (order) twice as often.

– To reduce batch size by a factor of 2, setup cost has to be reduced by a factor of 4.

Continuous vs. Periodic Review


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recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

Copyright © 2013 Pearson Education Inc. publishing as Prentice Hall

managing business process flows: ch 6 supply chain management managing the supply chain key to...

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