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Summary Lectures + book chapters Supply Chain design and planning (325239-M-6)
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Summary Supply chain design and planningInhoud
Lecture 2: Inventory Management and Risk Pooling............................................................................................... 2
Book Chapter 2 .................................................................................................................................................... 2
Slides ................................................................................................................................................................... 7
Case study ......................................................................................................................................................... 12
Lecture 3: Supply contracts ................................................................................................................................... 14
Book Chapter 4 .................................................................................................................................................. 14
Slides ................................................................................................................................................................. 17
Lecture 4: The value of information ...................................................................................................................... 22
Book chapter 5 .................................................................................................................................................. 22
Slides ................................................................................................................................................................. 26
Lecture 5: Supply chain integration ....................................................................................................................... 30
Book chapter 6 .................................................................................................................................................. 30
Slides ................................................................................................................................................................. 34
Lecture 6: Sustainability ........................................................................................................................................ 37
Slides ................................................................................................................................................................. 37
Case: Interface and Its Evergreen Services Agreement ..................................................................................... 41
Lecture 7: Sales & operations planning ................................................................................................................. 44
Boek forecasting ................................................................................................................................................ 44
Slides ................................................................................................................................................................. 48
Lecture 9: Network planning and distribution strategies ...................................................................................... 51
Book chapter 7 .................................................................................................................................................. 51
Slides ................................................................................................................................................................. 55
Lecture 10: Smart pricing ...................................................................................................................................... 59
Book chapter 13 ................................................................................................................................................ 59
Slides ................................................................................................................................................................. 63
Lecture 11: Coordinated product and supply chain design ................................................................................... 68
Book chapter 11 ................................................................................................................................................ 68
Slides ................................................................................................................................................................. 74
,Lecture 2: Inventory Management and Risk Pooling
Book Chapter 2
By the end of this chapter, you will understand the following issues:
• How firms cope with variability in customer demand.
• What the relationship is between service and inventory levels.
• What impact lead time and lead time variability have on inventory levels.
• What an effective inventory management policy is.
• What approaches can be used to forecast future demand.
2.1 Introduction
The goal of effective inventory management in the supply chain is to have the correct inventory at the right
place at the right time to minimize system costs while satisfying customer service requirements, and inventory
levels that are inappropriately reduced can obviously hurt customer service.
Types of inventory: Raw materials, component inventory, Work in process and finished products.
Why hold inventory?
- Unexpected changes in customer demand
- Uncertainty in quantity and quality of supply
- Manufacturing and delivery Lead times
- Economies of scale in transportation and manufacturing
The demand forecast is critical for determining what to order, and when to order it.
Inventory policy: The strategy, approach, or set of techniques used to determine how to manage inventory.
To decide effective inventory policy, characteristics of the supply chain tot take into account:
- Nature of customer demand (average customer demand and variability).
- Lead times in the system, including manufacturing and transportation times and lead times of suppliers.
- Number of products, these products may compete for manufacturing capacity, budget and space.
- Length of the planning horizon
- Costs, order cost and inventory holding costs
- Service level requirements
2.2 Single stage inventory control
We start by considering inventory management in a single supply chain stage. Variety of techniques and
approaches. Each approach will be increasingly more complex and has different assumptions for the
calculations. For examples and calculations, review the chapter.
2.2.1 Stable Demand-the Economic Lot Size Model
Trade-offs between ordering and storage costs. Warehouse facing constant stable demand for a single item. The
model assumes constant demand and no lead times. Our goal is to find the optimal order policy that minimizes
annual purchasing and carrying costs while meeting all demand.
The simple model provides two important insights:
1. An optimal policy balances inventory holding cost per unit time with setup cost per unit time.
2. Total inventory cost is insensitive to order quantities; that is, changes in order quantities have a relatively
small impact on annual setup costs and inventory holding costs.
,2.2.2 Known Demand Changing Over Time
Similar trade-offs exist if demand is changing over time, although in this case, order quantities change over t
time periods. Our goal in this instance is to find a set of orders that minimizes purchasing and carrying costs
while meeting all demand. This model, however, relaxes a key restriction of the economic lot size model-orders
change over time to reflect changing demand. In any period, it never makes sense to both carry inventory from
the previous period and also order, because if an order is placed, the fixed cost K is incurred anyway.
2.2.3 The Effect of Demand Uncertainty
The previous model illustrates the trade-offs between setup costs and inventory holding costs. It ignores,
however, issues such as demand uncertainty and forecasting.
Principles of all forecasts
1. The forecast is always wrong.
2. The longer the forecast horizon, the worse the forecast.
3. Aggregate forecasts are more accurate (easier to predict demand across all SKUs in one product family).
2.2.4 Single Period Models
To better understand the impact of demand uncertainty, we consider a series of increasingly detailed and
complex situations.
(1) we consider a product that has a short life cycle, and hence the firm has only one ordering opportunity.
• If the firm stocks too much, it will be stuck with excess inventory it has to dispose of
• If the firm stocks too little, it will forgo some sales, and thus some profits.
Using historical data, the firm can typically identify demand scenarios to determine a probability and associated
profit that each of these scenarios will occur. It is, thus, natural for the firm to order the quantity that maximizes
the average profit, which is not necessarily the same is the average demand.
So, what is the relationship between the optimal order, or production, quantity, and average demand?
To answer, we compare the marginal profit and the marginal cost of ordering an additional unit.
• If an additional unit is sold, the marginal profit is the difference between the selling price per unit and the
variable ordering (or production) cost per unit.
• If an additional unit is not sold during the selling season, the marginal cost is the difference between the
variable production cost and the salvage value per unit.
> If the cost of not selling an additional unit is larger than the profit from selling an additional unit, the optimal
quantity in general will be less than the average demand, whereas if the reverse is true, the optimal order
quantity in general will be greater than the average demand.
> As the order quantity increases, average profit typically increases until the production quantity reaches a
certain value, after which the average profit starts decreasing.
> As we increase the production quantity, the risk-that is, the probability of large losses-always increases. At the
same time, the probability of large gains also increases. This is the risk/reward trade-off.
2.2.5 Initial Inventory
What if we have inventory left over from a previous seasons? when initial inventory is available, the trade-off is
between having a limited amount of inventory by avoiding paying the fixed cost versus paying the fixed cost,
and therefore having a higher inventory level.
, A powerful inventory policy used in practice to manage inventory: Whenever the inventory level is reviewed, if
it is below a certain value, say, s (reorder point), we order to increase the inventory to level S (order-up-to-
level). Such a policy is referred as an (s, S) policy or a min-max policy.
2.2.6 The Newsvendor Model
Sometimes rather than scenarios, the demand is given in the form of a distribution (normal distribution with an
average and standard deviation).
2.2.7 Multiple Order Opportunities
In many practical situations, the decision maker may order products repeatedly at any time during the year. In
this case, the manufacturer cannot instantaneously satisfy orders placed by the distributor: There is a fixed lead
time for delivery. Therefore the retailer must hold inventory, 3 reasons:
- To satisfy demand occurring during lead time.
- To protect against uncertainty in demand.
- To balance annual inventory holding costs and annual fixed order costs. More frequent orders lead to lower
inventory levels and thus lower inventory holding costs, but they also lead to higher annual fixed order costs.
To manage inventory effectively, the distributor needs to decide when and how much to order. We distinguish
between two types of policies: Continuous review policy or Periodic review policy.
2.2.8 Continuous Review Policy
Inventory is reviewed continuously, and an order is placed when the inventory reaches a particular level, or
reorder point. It is based on:
AVG = Average daily demand, STD = Standard deviation of daily demand, L = lead time, h = cost of holding one
unit, a = service level.
For the continuous review model, we employ the (Q, R) policy-whenever inventory level falls to a reorder level
R, place an order for Q units.
> The reorder level R is based on the average inventory during lead time and the safety stock.
> The order quantity Q is based on the EOQ order quantity.
2.2.9 Variable Lead Times
In many cases, the assumption that the delivery lead time to the warehouse is fixed and known in advance does
not necessarily hold. In these cases, we typically assume that the lead time is normally distributed with average
lead time. This changes the calculation of the Reorder point.
2.2.10 Periodic Review Policy
The inventory level is reviewed at regular intervals and an appropriate quantity is ordered after each review.
• Short intervals (daily); define two inventory levels s and S, and during each inventory review, if the inventory
position falls below s, order enough to raise the inventory position to S (s, S policy).
• Larger intervals (weekly or monthly); Since an order is placed after each inventory review, the fixed cost of
placing an order is a sunk cost, and hence can be ignored; the inventory policy is characterized by the base-
stock level, the warehouse determines a target inventory level, and each review period, the inventory position
is reviewed and the warehouse orders enough to raise the inventory position to the base-stock level.
> Set s = R and S = R+Q
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