managing business process flows: ch 6 supply chain management managing the supply chain key to...
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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
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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?
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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
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Costs of not Matching Supply and Demand
Cost of overstocking – liquidation, obsolescence, holding
Cost of under-stocking – lost sales and resulting lost margin
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Where is the Flow Time?
Buffer Operation
Waiting Processing
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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%
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Operational Flows
Throughput R
Inventory I
I = R T Flow time T = Inventory I / Throughput R
FLOW TIME T
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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
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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
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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 $2,200. To exploit economies of scale, stores typically ordered full truck loads. (Palü’s cost of capital is approximately 20%.)
What order size would you recommend for a Palü store in current supply network?
retailermanufacturer
Palü Gear: Retail Inventory Management & Economies of Scale
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Economies of Scale: Inventory Build-Up Diagram
R: Annual demand rate,
Q: Number of wind breakers per replenishment order
Number of orders per year = R/Q.
Average number of wind breakers in inventory = Q/2 .
Q
Time t
Inventory Profile:# of wind breakers in inventory over time.
Inventory
Q/2
“cycle stock”
-R = Demandrate
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Palü Gear: evaluation of current policy of ordering 1500 units each time
1. What is average inventory I? I = Annual cost to hold one unit H = Annual cost to hold I =
2. How often do we order? Annual throughput R = # of orders per year = Annual order cost =
3. What is total cost? TC =
4. What happens if order size changes?
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Find most economical order quantity: Spreadsheet for a Palü Gear retailer
Number of units Number ofper order/batch Batches per Annual Annual Annual
Q Year: R/Q Setup Cost Holding Cost Total Cost50 62 135,385$ 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
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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
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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
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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
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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
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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.
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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
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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
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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
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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),
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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
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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.
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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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