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Risk Pooling
Suppliers
Manufacturers
Warehouses
Distribution
Centers
Finished products
distributed to customers
Forms of Inventory:
Raw material inventory
Work-in-process inventory
Finished product inventory
Customers
Order cost
i.
ii.
b.
6.
Cost of product
Transportation cost
Taxes and insurance on inventories
Maintenance costs
Obsolescence costs
Opportunity costs
Inventori, I(t)
Gradient = demand
Q
-D
Cycle time
Sensitivity Analysis
How sensitive is the cost function to errors in
calculating Q (or if we deliberately order
something different that Q*)?
Let G* be the optimal cost:
G*= KD/Q* + hQ*/2
KD
h 2 KD
=
2 KD / h
2KDh
Sensitivity Analysis
Can be shown that
G(Q)/G* = (KD/Q + hQ/2)
2KDh
= [ Q*/Q + Q/Q*]
By substituting values, can be shown that G(Q) is
relatively insensitive to errors in Q.
For instance, 100% error in Q results only 25%
error in G(Q) (Table 3.1)
Insights
Optimal policy balances between inventory
cost per unit time and setup cost per unit
time (Figure 3.2); if we equate hQ/2 and
KD/Q, we will get the EOQ formula.
Total inventory cost is insensitive to order
quantities
Demand uncertainty
Case: Swimsuit example:
Illustrates:
Importance of incorporating demand
uncertainty and forecast demand
Importance of characterizing the impact of
demand uncertainty on the inventory policy
Case example
Motivates a powerful inventory policy used
in practice to manage inventory:
Whenever the inventory is below a certain
value, say s, we order or produce to increase
the level to S.
Also known as the (s,S) policy or a min max
policy.
s is the reorder point and S is the order-up-to
level
In the swimsuit example reorder point is 8500
units and the order-up to level is 12,000 units
Multiple order
So far we only consider only a single
ordering decision for entire planning
horizon
For some products it might be true because of
short selling season and there is no
opportunity to reorder products
Multiple order
ACME Problem
Current distribution system uses different
warehouses to serve separate markets
We have warehouses in Newton,
Massachusetts and Parasmus, New Jersey
The ACME example considers locating only
one warehouse (somewhere between
Parasmus and Newton) to replace the existing
two, which is named central in the example
Conducts a detailed inventory analysis based on
two products and discover that a significant
reduction of average inventory can be achieved
for both products
Risk pooling
Important concept in scm
Replace existing warehouses with fewer strategically placed
ones
ACME example considers replacing two warehouses with one
Use the concept of coefficient of variation
Coeff of var = std dev/ avg demand
Measures variability wrt average demand as opposed to standard deviation
which measures absolute variabilty of customer demand
Risk Pooling
Essentially it is a centralized distribution system
Critical points:
1. Centralizing inventory reduces safety stock
and average inventory in the system.
---reallocation not possible in a decentralized
distribution system where different warehouses serve
different markets
2. The higher the coefficient of variation, the greater the
benefit obtained from centralized systems
3. The benefits from risk pooling depend on the
behavior of demand from one market relative to
demand from another.
Benefit decreases as correlation between demand
from two markets become more positive
Centralized vs decentralized
Safety stock
Safety stock decreases for centralized
Service level
Centralize is higher when both centralize and decentralize have same
safety stock
Overhead costs
Costs are greater in a decentralized system because fewer economies
of scale
Transportation costs
If we increase number of warehouses, outbound transportation costs
decreases because warehouse are closer to markets
Inbound transportation cost increases
Net impact is not totally clear
Depends on situation