part ii, logistics and scm

7/30/2019 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



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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



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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



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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



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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.


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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12-10

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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12-11

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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12-12

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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12-13

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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12-14

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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12-15

Types of Inventories (Contd)

Replacement parts, tools, & supplies

Goods-in-transit to warehouses or customers


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12-16

Functions of Inventory

To meet anticipated demand

To smooth production requirements

To decouple operations

To protect against stock-outs


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12-17

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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12-18

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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12-20

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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12-21

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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12-22

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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12-23

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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12-24

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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12-25

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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12-26

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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12-27

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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12-28

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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12-30

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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12-31

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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12-32

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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12-35

Total Costs with Purchasing Cost

Annualcarryingcost

PurchasingcostTC = +

Q2

H DQ

STC = +

+Annualorderingcost

PD +


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12-36

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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12-37

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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12-39

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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12-41

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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12-43

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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12-44

Requires a larger safety stock Increases carrying cost Costs of periodic reviews

Fixed-Interval Disadvantages


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12-45

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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12-47

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

part ii, logistics and scm

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