2 Module Logistics Management
(Inventory, Warehousing & Transportation)
1
Background: Logistics Management
"The part of SCM that plans,
implements, and controls the efficient, effective forward and reverse flow and storage of goods and services, related information, and money between the point of origin and the point of Upstream Downstream or consumption in order to meet or Forward Backward customers' requirements." -CSCMP
2
Logistics in the U.S. Economy
Components of 2008 Logistics Costs ($B)
Inventory Carrying Costs (all business inventory: $2.064 trillion) Interest $ 4 Taxes, obsolescence, depreciation, insurance 280 Warehousing 112
Total Inventory-Related Costs
Transportation costs Motor carriers: Truck-intercity Truck-local Subtotal
$396
3
$403 189 $592
Logistics in U.S. Economy, cont.
Other carriers: Railroads $ 60 Water (inter. 33; domestic 5) Oil pipelines 10 Air (inter. 16; domestic 25) Forwarders 32 Subtotal $168
33 33
Total Transportation Costs $760 56
4
Administration / Shipper Costs
$
TOTAL LOGISTICS COST $1,344
Logistics Costs
Year Inventory Carry Cost
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2008 5 2009 2010 31 38 56 97 220 227 283 302 374 395 420 360 396
Transport Costs
44 64 91 116 214 274 351 441 594 739 864 697 769
Admin Costs
3 4 6 9 17 20 25 30 39 46 52 43 47
Total U.S. Logistics Logistics Cost As % of GDP
78 106 153 222 451 521 659 773 1,007 1,180 1,344 1,100 1,212 14.7 14.7 14.7 13.5 16.1 12.3 11.4 10.4 10.3 9.5 9.4 7.8 8.3
Logistics Costs as % of GDP
0.17 0.16 0.15 0.14 0.13 0.12 0.11 0.1 0.09 0.08 0.07
6
Transport and Inventory Costs % of GDP
0.09 0.08 0.07 0.06 0.05 0.04 0.03 0.02
7
WHY LOGISTICS NOW? THE DRIVING CHANGE!
Deregulation Technology Power shift in the supply
chain Globalization
8
EXAMPLES OF LOGISTICS COST TRADE-OFFS
Inventory vs. Production (order cycle
length) Inventory vs. Cost of lost sales (COLS) Transportation vs. COLS Transportation vs. Inventory Transportation vs. Warehousing Total Logistics Concept: to find the lowest total cost that supports an organization's customer service requirements
9
Cost of Lost Sales vs. Inventory Cost
Total Cost Inventor y
$
COLS Units
Cost of Lost Sales vs. Transportation Costs
Total Cost
$
Transportatio n Costs
COLS 50% 100 Service
Chapter 7 Inventory Management
12
Course Topics Overview
Supply Management
Purchasing Supplier relationships Strategic Sourcing
Operations Management
Forecasting Inventory Mgmt Resource Planning Process Mgmt
Distribution
Warehousing Transportation Modes International Logistics Transportation Mgmt
Integration
Project Management Process Integration Performance Measurement
Inventory Definition and Basic Types
Inventory - the stock of any item or resource used in an organization
Four broad categories of
14
inventories Finished goods Raw materials Work-in-process (WIP) Maintenance, repair & operating (MRO)
Functions of Inventory
Two primary functions of inventory: 1. Buffer uncertainty in the marketplace
i.e. satisfy customer demand Meet Independent demand:
Set by market conditions Independent of operations `Replenishment' philosophy
2. Decouple dependencies in the supply chain i.e. facilitate production Meet Dependent demand:
Components and assemblies for creating good or service Demand is dependent on the factory or service schedule Demand comes in clumps `Requirements' philosophy
15
Why Inventory Management?
Right product, right point-in-time, right place to meet customer demand What, Where, When, How Many? $$$$ - Inventory is a significant portion of working capital Wal-Mart1 $29 billion of finished goods inventory Over 5,000 retail locations 1,276 Wal-Mart stores, 1,838 Supercenters, 556 Sam's Clubs, 92 Neighborhood Markets, 1,617 stores in 9 countries 61,000 U.S. suppliers Laurie Sullivan, "Wal-Mart's Way," 1Source:
Informationweek.com (September 27,2004), pp. 36-50
Item cost direct costs traceable to each unit
Inventory-Related Costs
17
for material and labor Ordering or setup costs Carrying (holding) costs Risk Costs Obsolescence Inventory shrinkage Storage Space Costs Variable storage and handling costs Service Costs Insurance costs Taxes Capital or Finance Costs Interest charges Opportunity cost
How much inventory is there?
Inventory accuracy refers to how well
the inventory records agree with physical count.
Cycle Counting is a physical
18
inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year.
Inventory System
Supply Rate Inventory Level
Inventory system: the
19
set of policies and controls that monitor levels of inventory and determines: 1. How much do I order? 2. What inventory level should be maintained? 3. When should orders be placed?
Inventory Level
Demand Rate
Tools Used to Manage Inventory
1. How much do I order? EOQ Price Break Model 2. What inventory level should be maintained? Reorder Point Safety Stock 3. When should orders be placed? Periodic Review Continuous Review 4. How much effort to put into managing inventory? ABC inventory analysis Inventory turnover analysis
20
Economic Order Quantity (EOQ)
Answers the question `How much do I
order?'
Used for independent demand items. Objective is to find order quantity (Q)
that minimizes the total cost (TC) of managing inventory.
Basic EOQ Model BehaviorQuantity = 400 Order
Inve ntory 400
units Order cycle time = 10 days Order Daily Demand = 20 arrival units
Order place d Order placed
Order arrival Average cycle inventory
200
0 Days
22
10
20
30
40
50
60
EOQ with reorder point system
IP = OH + SR- BO Order received Q OH ROP Order placed L TBO TBO OH Order placed L Q OH IP Order received
Inventory
Q
Q
0
23
Time
Simple EOQ Model
Assumptions
Demand known and constant Order lead time known and constant Full replenishment (entire order
delivered at one time) Price is constant, no quantity or price discounts Order cost is known and constant No stockouts No limits on capital availability
24
Cost Minimization Goal By adding the item, holding, and ordering costs
together, we determine the total cost curve, which in turn is used to find the Economic Order Quantity (EOQ) that minimizes total costs.
C O S T
Total Annual Inventory Cost (TAIC)
Annual Holding Costs (AHC) Annual Purchase Cost (APC) Annual Ordering Costs (AOC)
25
Economic Order Quantity (EOQ)
Total Annual Inventory Cost =
EOQ Model Annual Annual Formula + Ordering Purchase
Cost Cost
Annual + Holding Cost
Annual Demand
x
Cost Per Unit
# of Orders Per Year
x
Ordering Cost Per Order
Average Inventory
x
Annual Holding Cost Per Unit
R
x
C
+
R/Q x
S
+
Q/2
x
kxC
T AI C
R Q = RC + S + kC Q 2
26
Deriving the EOQ
Using calculus, we take the first derivative of the total cost function with respect to Q, and set the derivative (slope) equal to zero, solving for the optimized (cost minimized) value of Q.
EOQ =
2RS = kC
2( Annual Demand )( Order or Setup Cost ) Annual Holding Cost
27
EOQ Example
Given the information below, what is the EOQ?
Annual Demand = 1,000 units Cost to place an order = $10 Holding cost per unit per year = k x C = $2.50 Cost per unit = $15
28
EOQ Example Solution
EOQ = 2RS = kC 2(1,000 )(10) = 89.443 units or 89 units 2.50
In conclusion, you place an optimal order of 89 units when the inventory position hits the reorder point.
R Q 1,000 89 TAIC = RC + S + KC = 1,000 (15) + (10) + (2.5) = $15,223.61 Q 2 89 2
112.36
29
111.25
HOW MUCH TO (RE)ORDER: SUMMARY
Summary and Evaluation of EOQ Approach:
EOQ is a popular inventory model. EOQ doesn't handle multiple locations
well.
EOQ doesn't do well when demand is
not constant.
30
Minor adjustments can be made to the
Special Purpose EOQ Model: Price-Break Model Formula
Based on the same assumptions as the EOQ model, the price-break model has a similar EOQ formula:
EOQ =
2RS = kC
2(Annual Demand)(Order or Setup Cost) Annual Holding Cost
k = holding rate C = cost per unit
Since "C" changes for each price-break, the formula above will have to be used with each price-break cost value. Calculate EOQ for ALL price breaks
The Price-Break Model always requires 2 steps:
1. 2.
31
Based the results from 1, calculate TAIC for ALL price breaks and choose based on lowest TAIC.
Price-Break Example Problem: Data has a chance to reduce their inventory costs by A company
placing larger quantity orders using the price-break order quantity schedule below. What should their optimal order quantity be if this company purchases this single inventory item with an e-mail ordering cost of $4, a carrying cost rate of 20% of the inventory cost of the item, and an annual demand of 10,000 units?
Order Quantity(units) Price/unit($) 0 to 999 $30.00 1,000 to 1,499 $29.75 1,500 or more $29.50
32
Price-Break Example Problem: Annual Demand (R)= 10,000 units Carrying cost % of unit cost (k) = Solution part 1 Cost to place an order (S)= $4 20%
Cost per unit (C) = $30.00, Beginning with the lowest unit cost, determine if the $29.75, $29.50
computed EOQ values are feasible or not.
Interval from 1500 & more, the EOQ value is not feasible. Interval from 10001499, the EOQt value is not feasible. Interval from 0 to 999, the EOQ value is feasible. 33
EOQ =
2RS = kC 2RS = kC 2RS = kC
2(10,000)(4) = 116 units 0.2(29.50) 2(10,000)(4) = 116 units 0.2(29.75) 2(10,000)(4) = 115 units 0.2(30.00)
EOQ =
EOQ =
Total cost curves if any quantity could be ordered at each price
C = 30.00 C = 29.75 C = 29.50 EOQ = 115 EOQ = 116 EOQ = 116
Total Cost ($) 0
34
500
1000 Order Quantity
1500
2000
Actual total cost curve
C = 30.00
Total Cost ($)
C = 29.75 C = 29.50 Q = 115 Q = 1000 Q = 1500
0
35
500
1000 Order Quantity
1500
2000
Price-Break Problem: Example Annual Demand (R)= 10,000 units Carrying cost % of unit cost (k) = Solution part 1 Cost to place an order (S)= $4 20%
Cost per unit (C) = $30.00, Beginning with the lowest unit cost, determine if the $29.75, $29.50
computed EOQ values are feasible or not.
Interval from 1500 & Q = 1500 for price 2RS EOQ = = of $29.50 more, the EOQ value is kC not feasible. Interval from 1000- Q = 1000 for price 2RS EOQ = 1499, the EOQt value is of $29.75 kC = not feasible. Interval from 0 to 999,= 115 for price 2RS = Q EOQ = of $30.00 the EOQ value is kC feasible. 36
2(10,000)(4) = 116 units 0.2(29.50) 2(10,000)(4) = 116 units 0.2(29.75) 2(10,000)(4) = 115 units 0.2(30.00)
Problem: Solution cont.
Step 2: plug the feasible EOQ values into the total cost annual cost function to determine the total cost for each order quantity.
R Q TAIC = RC + S+ kC Q 2
37
Price-Break Example Problem: TAIC(115)= Solution part 2 (10000*$30.00)+(10000/115)*4+(115/2)*(0.2*$30.00) =
$300,693 TAIC(1000)= (10,000*$29.75) + (10,000/1000)*4 + (1000/2)*(0.2*$29.75) = $300,515 TAIC(1500) = (10,000*$29.50) + (10,000/1500)*4 + (1500/2)*(0.2*$29.50) = $299,452
Finally, we select the least costly EOQ, which is this problem occurs for an order quantity of 1500. Conclusion: the optimal order quantity is 1500 units.
38
Price-Break Model Practice Problem
Annual Forecast: 12,000 units Order processing cost: $125/order Inventory Carrying rate: 20% per year
Unit Price Supplier 1 1 to 999 units/order 1000 to 2999 units/order 3000+ units/order
39
$510 $500 $490
Price-Break Practice Problem : Annual Demand (R)= 12,000 units Carrying cost % of unit cost (k) = Solution part 1 Cost to place an order (S)= $125 20%
Cost per unit (C) = $510.00, Beginning with the lowest unit cost, determine if the $500.00, $490.00
computed EOQ values are feasible or not.
Interval from 3000 & more, the EOQ value is not feasible. Interval from 10002999, the EOQ value is not feasible. Interval from 0 to 999, the EOQ value is feasible. 40
EOQ =
2RS = kC 2RS = kC 2RS = kC
2(12,000)(125) = 175 units 0.2(490) 2(12,000)(125) = 173 units 0.2(500) 2(12,000)(125) = 171 units 0.2(510)
EOQ =
EOQ =
Price-Break Practice Problem: TAIC(171)= Solution part 2 (12000*$510.00)+(12000/171)*125+(171/2)*(0.2*$510.00) =
$6,137,493 TAIC(1000)= (12000*$500.00)+(12000/1000)*125+(1000/2)*(0.2*$500.00) = $6,051,500 TAIC(3000) = (12000*$490.00)+(12000/3000)*125+(3000/2)*(0.2*$490.00) = $6,027,500
Finally, we select the least costly EOQ, which is this problem occurs for an order quantity of 3000.
Conclusion: the optimal order quantity is 3000 units.
41
Tools to Manage Inventory
1. How much do I order? EOQ Price Break Model 2. What inventory level should be
Supply Rate Inventory Level
maintained?
Inventory Level
Reorder Point Safety Stock
3. When should orders be placed? Periodic Review Demand Rate Continuous Review 4. How much effort to put into managing
inventory?
42
ABC inventory analysis
What inventory level should be maintained?
If both demand and lead time are constant:
Reorder point, ROP = d x LT
d = average demand (constant) LT = Lead time (constant)
_
_
43
EOQ System How much inventory?
IP Order received If demand equals 50 units per week and the lead time is 4 weeks, ROP = 50*4 =200 units
Inventory
Q OH
ROP Order placed L
ROP = d x LT
0
44
Time
EOQ System: Demand & Lead Time Uncertainty
Uncertainty is a normal condition Demand is often affected by exogenous factors---weather, forgetfulness, etc. Lead times often vary regardless of carrier intentions Reorder Point Becomes the average demand during lead time plus the safety stock
45
EOQ System With Uncertainty: Demand & Lead Time Variability IP
Inventory OH
ROP
ROP = d x LT +SS
0 Safety Stock (Is)
46
Time
Lead time may also vary
Stockout risk
ROP = d LT + SS
ROP & Safety Stock Calculations
2 SS = z d + d LT 2 LT
2
Where: d is the standard deviation of demand LT is the standard deviation of lead time z is the number of standard deviations for a 47 specified service probability (see z-
Probabi listic LT (i.e., LT varies)
Probab ilistic d (i.e., d varies)
Safety Stock (x-) (calcul x ate Averag using Reorder e formul point demanlisted a
EOQ System Example: demand and lead 4time variability d = 50 units/week LT = weeks Desired service
level = 85% Standard deviation of weekly demand = d = 10 units/week 2 2 2 ROP = d LT + SS = d of lead time = d LT 1.5 weeks Standard deviation LT + z LT d + LT =
= 50 4 + 1.04 2.25 2500 + 100 4
= 200 + 80.73 = 280.73 281 units SS = 81 units If lead time was constant and demand variable ROP = 200 + 20.8 = 220.8 221 units SS = 21 u
48
If demand was constant and lead time variable ROP = 200 + 78 = 278 SS = 78 units
Safety Stock Example: What about better service levels?
d = 50 units/week LT = 4 weeks Desired service level = 99% Standard deviation of weekly demand = d = 10 units/week 2 2 2 ROP = d LT + SS = d of lead time = d LT 1.5 weeks Standard deviation LT + z LT d + LT =
= 50 4 + 2.33 2.25 2500 + 100 4
= 200 + 180.85 = 380.85 381units SS = 181units If lead time was constant and demand variable: ROP = 200 + 46.4 = 246.4 246 units SS = 46 un
49
If demand was constant and lead time variable: ROP = 200 + 174.75 = 374.75 375 SS = 175 un
So...What service level is best?
What are the differences between an 85%
of a 99% service level?
What are the pros and cons for each? Which is best for your firm? How do demand and lead time uncertainty
affect the inventory management policies of the firm?
50
ROP & SS: Practice Problem
1. Lindner Congress Bookstore sells a unique
calculator to college students. The demand for this calculator has a normal distribution with an average daily demand of 15 units and a standard deviation of 4 units per day. The order lead time for this calculator is very stable at 5 days. Determine the safety stock and statistical reorder point that result in a 95 percent service level.
51
ROP & SS: Practice ANSWER
Lindner Congress Bookstore sells a unique calculator to college students. The demand for this calculator has a normal distribution with an average daily demand of 15 units and a standard deviation of 4 units per day. The order lead time for this calculator is very stable at 5 days. Determine the safety stock and statistical reorder point that result in a 95 percent service level.
Safety stock = 14.76 units Statistical reorder point = 89.76 units
52
Variability & Average Inventory
Since safety stock on average is not consumed, the average inventory level including safety stock can be found by: What else does this impact???
Average Inventory = Q/2 + SS
Average Inventory impacts TAIC: R Q
53
TAIC = RC + S + +SS kC Q 2
Continuous Review (Q) System
Fixed-Order Quantity Model
When should orders be placed?
stock)
Event triggered (Example: running out of
Allows for random demand Stock position is monitored continuously
Periodic Review (P) System
Fixed-Time Period Model
Time triggered (Example: Monthly sales call
by sales rep.)
Assume demand is random Order up to the `target' level at a specified time
54
Continuous Review (Q) System
55
R = Reorder Point Q = Order Quantity L = Lead time
Periodic Review (P) System
At specified time order Q necessary to
reach the target inventory (T).
56
Tools to Manage Inventory
1. How much do I order? EOQ Price Break Model 2. What inventory level should be
Supply Rate Inventory Level
maintained?
Inventory Level
Reorder Point Safety Stock
3. When should orders be placed? Periodic Review Demand Rate Continuous Review 4. How much effort to put into managing
inventory?
57
ABC inventory analysis
How much effort goes to Inventory Mgmt?
ABC Method of Inventory Analysis
Determine annual $ usage Rank the items according to
annual $ usage
58
ABC Analysis
Percentage of dollar value
100 -- 90 -- 80 -- 70 -- 60 -- 50 -- 40 -- 30 -- 20 -- 10 -- 0--
59
Class B Class A
Class C
10 20 30 40 50 60 70 80 90 100 Percentage of items
Example
ITEM A1 B2 C3 D4 E5 F6 G7 H8 I9 J10 COST $46 $40 $5 $81 $22 $6 $176 $6 $10 $14 DEMAND 200 10 6680 100 50 100 250 150 10 50 $ USAGE $9,200 $400 $33,400 $8100 $1100 $600 $44,000 $900 $100 $700
Total $ Usage
60
$98,500
Item
Ranking by Annual $ $ Usage Cumulative $ Usage Usage
$44,000 $77,400 $86,600 $94,700 $95,800 $96,700 $97,400 $98,000 $98,400 $98,500 Blue = "B" items
% of Total
G7 $44,000 44.7% C3 $33,400 A1 $9,200 D4 $8,100 E5 $1,100 H8 $900 J10 $700 F6 $600 B2 $400 I9 $100 Red = "A" items
61
44,000/98,500 = 78.6% 87.9% 96.1% 97.3% 98.2% 98.9% 99.5% 99.9% 100% Black = "C" items
Inventory Investment Firms should diligently measure inventory
Evaluating Inventory Management
investment to ensure that it does not adversely affect competitiveness. Measures include:
Absolute value of inventory (found on balance
sheet) Inventory turnover or turnover ratio- how many Cost of Revenue Inventory Turnover Ratio = times inventory "turns" in an accounting period. Average Inventory Faster is better!
62
Cost of Goods Sold = Average Aggregate Inventory Level
Inventory Turnover The following information was obtained from the Analysis annual financial statements of two different
companies. Which company is performing better with respect to managing their inventories? B Company A Company
Raw Materials WIP Finished Goods Cost of Goods Sold $350,000 $565,000 $435,000 $6,075,000 $275,000 $434,000 $366,000 $3,440,000
Cost of Goods Sold Inventory Turnover = Average Aggregate Inventory Level
Company A: 6,075,000 / (350,000 + 565,000 + 435,000) = 4.5 turns/year Company B: 3,440,000 / (275,000 + 434,000 + 366,000) = 3.20 turns/year Company A is doing better.
63