Introduction to Business

Logistics Management


Lecture 11
Determining the Optimal Level of Product Availability
Newsvendor Models


Outline

1. Introduction
2. The newsboy model
Uniform Distribution of Demand
Normal Distribution of Demand
3. Periodic review policy

Outline
2
1. Introduction
Demand is uncertain:

Type of Inventory Systems
Periodic Review
Continuous Review

Optimization Criteria:
Minimize Expected cost
Service Level
Ran Det
D D D + =
3
Inventory Control
Subject To Uncertain Demand
The demand is not known. Demand characteristics
such as mean, standard deviation and the distribution
of demand may be known.
Stock-out cost: The cost associated with a loss of
sales when demand cannot be met. For example, if
an item is purchased at $1.50 and sold at $3.00, the
loss of profit is $3.00-1.50 = $1.50 for each unit of
demand not fulfilled.

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Single- and Multi- Period Models
The classification applies to the probabilistic demand
case
In a single-period model, the items unsold at the end
of the period is not carried over to the next period.
The unsold items, however, may have some salvage
values.
In a multi-period model, all the items unsold at the
end of one period are available in the next period.
In the single-period model and in some of the multi-
period models, there remains only one question to
answer: how much to order.
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SINGLE-PERIOD MODEL
Perishable product
Seasonal products such as bathing suits, winter
coats, etc.
Newspaper and magazine
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Review of Basic Probability
Random variables
Cumulative distribution function
Probability mass function
Probability density function
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2. Newsboy models
Parameters:
D = Demand (rv): density function f(x), cdf F(x)
= Overage cost (loss of excess supply)
= Underage cost (loss of profits for under supply)
DV:
Q = # newspapers bought at beginning of period

0
c
u
c
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Example
$0.25 per newspaper to buy
$0.75 per newspaper to sell
$0.10 per newspaper unsold
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Trade-offs in a Single-Period Models
Loss resulting from the items unsold (overage cost)
c
o
= Purchase price - Salvage value

Profit resulting from the items sold (underage cost)
c
u
= Selling price - Purchase price

Trade-off
Given costs of overestimating/underestimating demand
and the probabilities of various demand sizes
how many units will be ordered?
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Demand Characteristics
Mean = 20
Standard deviation = 2.49
Demand Characteristics
Procedures
The optimal policy:


For normal D, Fs table determines value of z,


For uniform D:




u z Q + =o
*
u
u
c c
c
Q F
+
=
0
*
) (
a Q F a b Q + = ) ( * ) (
* *
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Example 1: The J&B Card Shop sells calendars. The once-
a-year order for each years calendar arrives in
September. The calendars cost $1.50 and J&B sells them
for $3 each. At the end of July, J&B reduces the calendar
price to $1 and can sell all the surplus calendars at this
price. How many calendars should J&B order if the
September-to-July demand can be approximated by
a. normal distribution with = 500 and o=120.
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Solution to Example 1:

Overage cost
c
o
= Purchase price - Salvage value =

Underage cost
c
u
= Selling price - Purchase price =


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Example 1 (b): How many calendars should J&B order if the
September-to-July demand can be approximated by
uniform distribution between 150 and 850
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Discrete Distribution
Compute F(Q)
Round Q up
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Example 3: Demand for cookies:
Demand Probability of Demand
1,800 dozen 0.05
2,000 0.10
2,200 0.20
2,400 0.30
2,600 0.20
2,800 0.10
3,000 0,05
Selling price=$0.69, cost=$0.49, salvage value=$0.29
a. What is the optimal number of cookies to make?
b. What is the profit or loss for the quantity? How about
2200?
c. Determine the optimal # of cookies using a normal
approximation.
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4. Periodic Review Policies
Impact of Replenishment Policies on Safety Inventory
Continuous Review Policies
D: Average demand per period
o
D
: Standard deviation of demand per period
L: Average lead time for replenishment
D L
L
L
DL D
o o =
=
Mean demand during lead time,
Standard deviation of demand during lead time,
ss D ROP L CSL NORMSINV CSL F ss
L D L S
+ = = = , ) ( ) (
1
o o
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Periodic Review Policies
Periodic Review Policies
Lot size determined by prespecified order-up-to level
(OUL)
D: Average demand per period
o
D
: Standard deviation of demand per period
L: Average lead time for replenishment
T: Review interval
CSL: Desired cycle service level
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Periodic Review Policies
Probability(demand during L + T OUL) = CSL
D L T D L T
L T
) ( periods, during demand Mean + = +
+
D L T
L T L T o o + = +
+
periods, during demand dev Std
DT D Q
CSL NORMSINV CSL F ss
ss D OUL
T
L T L D S
L T
= =
= =
+ =
+ +
+
size, lot Average
) ( ) (
1
o o
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Periodic Review Policies
Figure 12-6
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Example
Given:
D = 2,500/week, o
D
= 500, L = 2 weeks, T = 4 weeks

ss =? OUT =?
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Periodic Review Policies
000 , 15 500 , 2 ) 4 2 (
) ( periods, during demand Mean
= + =
+ = +
+
D L T D L T
L T
( ) 225 , 1 500 2 4
periods, during demand dev Std
= + =
+ = +
+ D L T
L T L T o o
boxes 570 , 1 225 , 1 ) 90 . 0 (
) ( ) (
1
= =
= =
+ +
NORMSINV
CSL NORMSINV CSL F ss
L T L D S
o o
570 , 16 570 , 1 000 , 15 = + = + =
+
ss D OUL
L T
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