L08 SCTools 042215

Supply Chain Analysis Tools
MS&E 262
Supply Chain Management
Im indebted to Dr. Mark Wilkinson, Senior Industrial Engineer and Intel

Technologist, Logic Technology Development, Intel Corporation for initial
organization of this PPT deck.
Motivation
Inventory/Service Trade-off Curve

High
Inventory
Low
Good
Poor
Service
Analytical tools help lower the curve!
Hausman and Wilkinson
Outline
Analytical Tools from MS&E 260/261
EOQ
Newsvendor
Lot Size Reorder (Q,R) Model
Periodic Review (T,S) Model
Supply Chain Improvement Tools
Standard Inventory Models

Case I
Case II
Case III
Demand: Known
Supply: Known
Demand: Unknown
Supply: Known
Demand: Unknown
Supply: Unknown
Ordering vs. Holding
Ordering vs. Holding
Underage/Overage
Underage/Overage
Trade-off:
Ordering Cost
Holding Cost
Penalty Costs:
None
Standard Inventory Models
Economic Order Quantity (EOQ)
Case I
Deterministic; determine order quantity
Newsvendor
Case II
Captures demand variability; determine one-time-shot quantity
Lot Size-Reorder Model
Case II/III
Includes variability in an on-going setting

Determine order quantity (Q) when an trigger level (R) is met
Periodic Review Model
Case II/III
Includes variability in an on-going setting

Determine order-up-to level (S) when ordering every T time units
Analytical Tools
Economic Order Quantity Model
How much to order/produce?

Fixed order cost of $ K
Inventory holding cost of $ h = $ Ic
Shortages prohibited
Deterministic (constant) demand rate per year, D
Inventory Level
Slope = -D
Q
T
(T = Q/D)
Time, t
Analytical Tools
EOQ Model - Derivation
G(Q) = cD + KD/Q + IcQ/2

Purchasing
Holding
Setup
Annual
Holding +
Setup Cost
Total = G(Q)-cD
Holding = IcQ/2
Setup = KD/Q
Q*
2 KD
Q
Ic
*
Analytical Tools
EOQ Model Sensitivities/Shortcomings
40 20 02 rule
40 % error in an input parameter results in 20 % error in
Q
The result is a 2 % increase in the costs, G(Q)
Cost function is relatively insensitive to errors in Q
Shortcomings of EOQ Model?

Zero lead time (easily extended to fixed lead time)
Infinite production rate (finite production rate, P, if P > D)
No shortages allowed (easily extendable)

Constant, deterministic demand rate
Analytical Tools
Newsvendor Model
Motivation:
At the start of each day, a newspaper vendor must decide
on the number of papers to purchase and sell. Daily sales
cannot be predicted exactly, and are represented by a
random variable, D.
Relevant Costs:
Co = unit cost of overage (not enough demand)
Cu = unit cost of underage (too much demand)
Example: Fashion (Ralph Lauren, Ann Taylor)

Retail: Stanford Shopping Center, Web Sites
Overage: Gilroy Outlet Mall
Analytical Tools
Newsvendor Model (cont.)
cu
F (Q )
cu co
*
Shortcomings of Newsvendor Model?

No consideration of positive lead times
One shot model (can be extended to multiple periods)

No setup cost for placing orders included
10
Analytical Tools
What is the Expected Profit?

Expected Demand = Expected Sales + Expected Lost Sales
Expected Lost Sales = L(z) s when demand follows normal distribution
L(z) is the standardized loss function for a Normal(0,1) distribution
Excel: L(z) = NORMDIST(z,0,1,False) z(1-NORMSDIST(z)) *
Order Quantity (Q) = Expected Sales + Expected Overage

Expected Overage = max (0, Q Expected Sales) no back orders
Expected Profit
* Nahmias 6th ed, p. 278
= (p - c) Expected Sales (c - s) Expected Overage

= (p - c) (m L(z) s) (c - s) (Q (m - L(z) s))
11
Lot Size Reorder Point (Q, R) Model
We need to decide two things:

How much to order each time we place an
order (Q)?
At which inventory position (R) do we order?
Inventory
Position
R
t
t= Lead Time
Time
Safety Stock
12
Safety Stock
Since demand (and possibly supply) is uncertain, the
system builds in safety stock to protect against uncertainty
during the reorder lead time.
Safety Stock = Insurance associated with uncertainty
Safety stock in the (Q,R) model is a function of:
Demand distribution (standard deviation of demand)

Desired availability (e.g., 99% probability demand satisfied)
Suppliers lead time duration
Suppliers availability and delivery randomness (Case III)
13
Analytical Tools
(Q,R) Model Notation:
Average demand rate/year l

Setup cost
K
Variable cost
c
Holding cost
h=Ic
Order quantity
Q
Reorder point
R
Lead time
t
Safety stock
s
14
Analytical Tools
(Q,R) Model Unit Shortage Cost p
The expected total annual cost (excluding lc) is
Kl
Q
l
G(Q, R)
Ic R lt p ( x R) f ( x)dx
Q
2
Q R
Setup
Holding
Shortage
Defining n(R) = E [# of units short in a cycle], we obtain
2l ( K pn( R ))
Q
Ic
QIc
F ( R) 1
pl
15
Analytical Tools
(Q,R) Model Unit Shortage Cost p (cont.)
For normally distributed

demand, define
L( z ) (t z ) (t )dt
where z = (R-mL)/sL.
Hence
n(R) = sL L(z)
Use the approximate solution:

Q = EOQ
Obtain z from tables for L(z)
R = mL + zsL
mL: mean lead time demand; sL: standard deviation of lead time demand
16
Analytical Tools
(Q,R) Model Service Level Approaches
Type 1:
Bad
a = Prob(no stockout in lead time)
Type 2:
Better
b = Proportion of demand met from on-hand stock

Recall n(R) = E[# of units short in cycle]
n ( R ) s L L( z )
1 b
Q
Q
L( z )
(1 b )Q
sL
17
Periodic Review (T, S) Model
Review every T time units

Order such that system inventory position
reaches S units at every review
Response Time = T + t
Inventory
Lead Time
Time
t
t
18
Analytical Tools
(T,S) Model (cont.)

T = EOQ/l
S = mt+T + z st+T
Where
mt+T = mean demand over t+T periods
st+T = standard deviation of demand over t+T periods
z
see (Q,R) model
Hence
Safety Stock = z st+T

19
Analytical Tools
Additional Tools/Methods
ABC Analysis
Exchange Curves
Forecasting
Scheduling
Aggregate Planning
Capacity Expansion
Optimization (LP, IP, MIP, DP)
20
Supply Chain Improvements
Uniform vs. Non-uniform Service Levels

Risk Pooling/Consolidation
Multi-Echelon Analysis
Postponement
Leadtime Reduction
Review Period Reduction
Variable Lead-time
21
Example 1: Risk Pooling/Consolidation
What is meant by Risk Pooling?
Example
Laser Printer Supply Chain
22
Laser Printer: Finished Goods Logistics

Penang, Malaysia
Long Beach
CA, USA
Memphis
TN, USA
Represents a DC location for distributor D1

http://www.ups.com/maps
23
UPS Ground Map for Memphis, TN
http://www.ups.com/maps
24
Laser Printers Distributor Network

Assume the following distributor network:
5 Independent Distributors (D1, D2, D3, D4, D5)
Each distributor operates 8 DCs across the US
Who are the distributors customers?
Relevant metrics for a DC?
25
Active Learning
Discuss opportunities for risk pooling:

For any particular distributor?
For any particular location (e.g., Memphis,
TN)?
For the original equipment mfr (OEM)?
26

Assume that:
1.
Demands at the multiple DCs are statistically

independent.
2. The means and standard deviations of demand for
the multiple product DCs are identical.
3. The leadtimes for the multiple DCs are
identical/constant.
4. The review periods at the DCs are identical.
5. The safety factors for the DCs are identical.
6. All DCs have the same inventory value.
27
Let:
si
demand
DC i;
= standard deviation of
per period at
ti
= lead time for DC i;
Ti
zi
= review period for DC i;

= safety factor for DC i;
= number of DCs in a region

(e.g., DCs in Memphis, TN).
28

Safety Stock at DCi = zis Ti t i
Total System Safety Stock =
i 1
zis Ti t i
System Safety Stock, Unpooled = nzs T t
System Safety Stock, Pooled =
n zs T t
29

Reduction Effect through Pooling:
SafetyStock,UnpooledTotal
- SafetyStock
,
PooledTotal
SafetyStock,UnpooledTotal
nzs T t - n zs T t
nzs T t
1
1
n
E.g., Reduction Effect in Memphis for n = 5: 55.3%
30
Example 2: Lead Time Reduction
31
Example 3: Postponement
Concept
Delay/postpone product differentiation until as
late as possible in the production process
Blanks
Manufacturer
SF
Warehouse
Intel
Mask Facility
a
B
Ba
Ba
Bb
Bb
B
32
Before Postponement
Delivery
Engineering
Supplier-coated blanks
B
t = 4 weeks
Daei
Ba
Production
Dapi
b
Engineering
Supplier-coated blanks
t = 4 weeks
Dbei
Bb
Production
Demand for blank B in week i =

resist
user
Drui
Dbpi
33
After Postponement
Delivery
In-house
Coating
Engineering
Daei
a
Ba
Production
t = 1-2 days
Dapi
Engineering
Uncoated blanks
t = 3 weeks
Dbei
b
In-house
Coating
Bb
Production
Dbpi
34
Summary
Use known tools as needed in projects

Understand underlying assumptions
Perform sensitivity analysis on different
parameters
At worst, simulate the system!
Analytical tools can help significantly improve
supply chain performance!
35
Details:
36
Analytical Tools
Lead Time Demand Variability

Expectation of Sum = Sum of Expectations
General Variance Formula (Lead time = t periods, demand in
period i = di)
t
s d2 s d2 2 COV (d i , d j ), where d LT d i
LT
i 1
i j
i 1
Variance of Sum = Sum of Variances (for independent variables)
Example: Lead time demand*

Mean
Variance
* assuming
mL = t m
sL2 = t s 2
independence between periods
37
Analytical Tools
Random Lead Times

If lead time is random, with mean t and variance s2
And demand in time t has mean mt and variance s 2t
Then the demand during (random) lead time has
Mean
mL = tm
Variance
sL2 = m 2 s2 +t s 2
*Assuming
orders do not cross and successive lead times are independent

38

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Supply Chain Analysis Tools

Im indebted to Dr. Mark Wilkinson, Senior Industrial Engineer and Intel

Inventory/Service Trade-off Curve

Supply Chain Improvement Tools

Hausman and Wilkinson

Standard Inventory Models

Ordering vs. Holding

Ordering vs. Holding

Hausman and Wilkinson

Standard Inventory Models

Economic Order Quantity (EOQ)

Deterministic; determine order quantity

Captures demand variability; determine one-time-shot quantity

Lot Size-Reorder Model

Includes variability in an on-going setting

Periodic Review Model

Includes variability in an on-going setting

Economic Order Quantity Model

How much to order/produce?

EOQ Model - Derivation

G(Q) = cD + KD/Q + IcQ/2

Hausman and Wilkinson

EOQ Model Sensitivities/Shortcomings

Shortcomings of EOQ Model?

No shortages allowed (easily extendable)

Hausman and Wilkinson

Example: Fashion (Ralph Lauren, Ann Taylor)

Newsvendor Model (cont.)

Shortcomings of Newsvendor Model?

One shot model (can be extended to multiple periods)

Hausman and Wilkinson

What is the Expected Profit?

Order Quantity (Q) = Expected Sales + Expected Overage

* Nahmias 6th ed, p. 278

= (p - c) Expected Sales (c - s) Expected Overage

Hausman and Wilkinson

Lot Size Reorder Point (Q, R) Model

We need to decide two things:

Safety stock in the (Q,R) model is a function of:

Demand distribution (standard deviation of demand)

Hausman and Wilkinson

(Q,R) Model Notation:

Average demand rate/year l

Hausman and Wilkinson

(Q,R) Model Unit Shortage Cost p

The expected total annual cost (excluding lc) is

Defining n(R) = E [# of units short in a cycle], we obtain

(Q,R) Model Unit Shortage Cost p (cont.)

For normally distributed

Use the approximate solution:

(Q,R) Model Service Level Approaches

a = Prob(no stockout in lead time)

b = Proportion of demand met from on-hand stock

Periodic Review (T, S) Model

Review every T time units

Hausman and Wilkinson

(T,S) Model (cont.)

Safety Stock = z st+T

Hausman and Wilkinson

Supply Chain Improvements

Uniform vs. Non-uniform Service Levels

Hausman and Wilkinson

Supply Chain Improvements