Study on Two- echelon Centralized Inventory Management Based on Supply Chain

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1 Study on Two- echelon Centralized Inventory Management Based on Supply Chain CHEN Zhiya, MAO Liuan, FANG Xiaoping School of Traffic and Transportation Engineering, Central South University, Changsha, China Abstract: Based on different demand from the downstream of the supply chain, a two-echelon centralized inventory control model of raw materials and finished products is built by improving the traditional multi-echelon inventory model in order to minimize enterprise s total inventory costs. A comparison of the two models is given, and it is found that the two-echelon centralized inventory control model can reduce inventory cost as well as improve service. An empirical research of a particular product in four manufacturers is done, it shows that the two-echelon centralized inventory control model can reduce inventory costs by.7%. Keywords: supply chain, two-echelon inventory, centralized management, comparison study Introduction The research of multi-echelon inventory started by Clark and Scarf in 960 [], they point that the optimum inventory management strategy is maximum ordering strategy. Since then, many researches of inventory management based on supply chain are done, they can be summarized and separated into the following kinds: () Production -Inventory System. () Inventory-distribution system. (3) Production-Inventory- distribution system. (4) Inventory distribution. Based on the article s characteristic and demand from downstream of the supply chain, the inventory management is studied from the angles of raw material inventory and finished goods inventory by using inventory and centralized inventory theory. There are two ways of multi- echelon inventory management, they are decentralized inventory strategy and centralized inventory strategy. Decentralized inventory strategy aims ultimately at inventory optimization of single enterprise or sector, it is usually secondary to the overall optimization of the whole supply chain. Centralized inventory strategy takes the link among all inventory control parameters into consideration, and then the integrated optimization of the whole supply chain can be achieved. Reference [] researches centralized inventory strategy, game inventory strategy and outsourcing strategy from the aspect of manufacturer, and finds the optimal level and applications of each strategy. References [3][5][6] multi- echelon inventory with a center warehouse. A inventory management model is built in order to make the optimize inventory management strategy of centralized inventory. References [][4] research SPP problem based on price discount, it supposes that order quantity and the practical demand are known. Through empirical analysis, this paper proves that it is practical to optimize order quantity and price by oint decision strategy. These researches are based on multi-echelon inventory theory of supply chain and manage inventory through oint strategy. These researches adopt the same inventory strategy in all kinds of inventory without considering the different needs in different situation, so they aren t confirm with the actual production. As to this problem, this paper researches the two-echelon inventory in different demand situation by using different inventory management strategy, and provides new ideas of multi-echelon inventory management strategy. Introduction of Two Kinds of Inventory Management Model 377

2 . Decentralized inventory management model Enterprise s internal inventories generally include raw materials inventory, semi-finished products inventory and finished products inventory. Inventory model usually is supply - production - distribution mode, manufacturing enterprise decentralized inventory management model is as figure. Figure : Decentralized inventory management model This kind of inventory usually calculates the optimal order quantity and the optimal order cycle by using the traditional inventory management method so as to minimize the inventory cost. This type of inventory management has some disadvantages: enterprise inventory management at different echelons is distributed, lacking of information communication, leading to enlarged demands and high total inventory costs, therefore optimal inventory cost can not be achieved. In the situation as figure, if the suppliers are not considered, each manufacturer must holds raw material inventory as well as finished products inventory at the same time. In this case, each factory has a huge inventory level which will results in high inventory costs.. Centralized inventory management model In order to improve the disadvantages of the decentralized inventory management model, this paper presents a two echelon centralized inventory management model as figure : It shows that there are two different points in structure comparing to decentralized inventory management model:() there is a central warehouse between suppliers and manufacturers;() there is regional distribution center between manufacturers and clients. In this model, the central warehouse holds the raw material inventory of all manufacturers. The establishment of regional distribution center changes the situation that each factory need to hold finished products inventory into several production factories sharing a region distribution center. The paper title and authors should be exactly in the format as indicated in this template in order to maintainuniformity throughout the conference proceedings. Figure :Centralized inventory management model (Note:S supplies, CW central warehouse, F factory, RDC--regional distribution center,c--clients) 3 Two-echelon Centralized Inventory Management Analysis In figure, there are two echelon inventories in the enterprise, they are central warehouse and regional distribution center. Inventory quality is determined according to the demand from downstream of the supply chain. The raw material demand of factories is stable and continuous, but the finished products 378

3 demand of clients is discrete and random. As to the demand in different situation, this paper establishes raw materials inventory and finished products inventory. 3. Raw material inventory Figure 3 shows raw materials inventory management of each factory in decentralized inventory management model, it uses a fixed ordering cycle T and adopts order quantity q. Figure 3 : Raw materials inventory management Since the raw materials demand of factories is stable and continuous, we adust the purchasing cycle and time to make each factory s ordering cycle to be the unit purchasing cycle or integer times of the unit purchasing cycle. The purchasing interval time of m factories is T / m, central warehouse holds the inventory of all factories. When the value of m is 4, the purchasing interval time is T/4, the inventory is as figure 4. Figure 4 : The inventory of factories and central warehouse after adusting production ( Note :F Factory, IQ Inventory quantity, CW Central warehouse) 379

4 Figure 5 :The inventory of regional distribution center (Note :PSQ product supply quantity, CDQ clients demand quantity, AIQ actual inventory quantity, PQ product quantity) Supposing that the decentralized inventory management mode of each branches' inventory is as Figure 4. By summing up all the branches inventory quantity after adusting their ordering time at the same time region,we can get that the central warehouse inventory turns up to be a relatively smooth curve. It can prove that every manufacturers demand can be met as long as inventory quantity of the central warehouse gets the maximum value of the curve. 3. The finished goods inventory Generally speaking, in the stable market situation, customers total demand for products is stable, but the individual customer's demand is random. Under distributed inventory management mode, manufacturers will often face shortages of goods. Cost will be high if they deploy goods from other manufacturers, while service quality will be low if they don t. Since the total product supply and demand among enterprises are generally equilibrium, establishment of regional distribution center between manufacturers and clients can ease the situation. Manufacturers put all finished goods in the regional distribution center, and the regional distribution center send the goods to customers according to their demands. Inventory of the regional distribution center is as Figure 5. 4 The Analysis on Inventory Cost of The Two Models This paper ust considers a kind of raw material and a kind of finished product, and supposes p units of raw material product one unit finished product. We don t consider transportation costs since the transport costs of the two modes are almost the same. 4. Decentralized two-echelon inventory model As figure, factories hold raw materials and finished products inventory, T is the fixed purchasing cycle, variables are as follows: D is raw materials demand of factory in cycle i, it is stable. i customer in cycle i, it is random. here i. n D i is finished product demand of R i is raw materials ordering quantity of factory in cycle i, R = R = K = R, andr is finished products ordering quantity of customer in cycle i S is raw material safety inventory of factory. c is the unit cost of raw material. K is fixed cost of factory at every time. h is the unit inventory cost of raw material, h is the unit inventory cost of finished product. Unit inventory costs of raw material and finished products in every manufacturer are the same. c is the unit shortage cost or deploying cost. Costs are as follows: 380

5 The raw materials ordering cost of factory in cycle i is OC = K + cd i ;stock turnover of factory in cycle i is R /. So raw material inventory cost of factory in cycle i is i SC = h ( R + s ),whend + s p> D, finished product inventory cost of factory in i i / i cycle i is SC = h [( D + s ) / p D )], when D > ( D + s ) p,inventory cost is zero, but i i i i / stock loss cost (or allocation cost) of factory in cycle i is OC = c [( D ( D s ) / p]. The total cost iscf f ( ) ( ) n m K+ cdi + h Ri + s = () i= = + h Di + s p D i + c Di ( Di + s) p i i + 4. Centralized two-echelon inventory model As figure, central warehouse holds raw materials inventory, distribution center holds finished product inventory, T is fixed ordering cycle, variables are as follows: D i is raw material demand of central warehouse in cycle i,which is stable, D i D i, finished product demand of all clients in cycle i, which is random, D i D i ; = = = D i is is Ri is raw material ordering quality of central warehouse in cycle i, R i R i, Ri is finished product ordering quantity of all clients in cycle i, R i R i = ; c is the finished product unit stock loss cost of distribution center; K is fixed cost of central warehouse at every ordering time. There is no need to hold safety inventory because raw material supply is stable in central warehouse l. Costs are as follows: The raw materials ordering cost of central warehouse in cycle i isoc = K + cd;stock i turnover in cycle i isr, So inventory cost of central warehouse in cycle i i is SC = hr i ; A there is no safety inventory in regional distribution center, so inventory cost in cycle i is SC = h ( Di p Di ).Total costs are n cf = [ K+ cdi + hri + h( Di p Di )] () i= 5 Numerical Examples One manufacturer has 4 factories, at first it adopts decentralized inventory management and orders goods according to demands, the demand cycle, safety inventory and fixed purchasing cost of each factory are as table. (T =30 Days, p,3 = c = CNY/PC, c = 30 CNY/PC, h = CNY/PC,0 h = CNY/PC) After adusting production and adopting centralized inventory management, the fixed ordering cost K of the central warehouse is 500 yuan. The demands of clients in one quarter are as table. 38

6 Table : the demand of factorys Factory Factory Factory3 Factory4 Cycle demand(pcs) Safety inventory(pcs) Fixed ordering cost (CNY) Finished produce quality(pcs) Table: the demand of clients clients clients clients3 clients4 anuary february march After adusting production and adopting centralized inventory management, the quantity of central warehouse inventory is as figure 4. Set T 4 as the cutoff point in one cycle, the maximum inventory quantities are 3580, 3400, 3500 and 960, and then choosing the maximum quality 3580 as the inventory quality of central warehouse. We calculated the cost of a quarter according to the formula () and () as follow: cf = CNY,0380 cf = CNY, f = cf = CNY f f cf It can be seen that the quarter inventory costs of the product is reduced by 38090CNY after adopting centralized inventory management, the inventory cost is.7% lower. 6 Results and Conclusion This paper studies the two-echelon centralized inventory management strategy of enterprise based on supply chain theory. We take different management strategies for two-echelon inventory according to the different demand stability of supply chain in order to achieve the lowest total cost. Comparing centralized inventory management strategy and decentralized inventory management strategy, we save the quarter inventory cost of one product by CNY which is.7% lower. In addition, this paper only considers the storage, ordering and shortage costs without taking inventory space cost and volume discounts into consideration, if considering these factors are taken into account, the result will be better. References []. Agrawal V, Seshadri S. Impact of uncertainty and risk aversion on pricing and order quantity in the news vender problem [J].Oper Manag,00,(4):40-43 []. Dong-Qing Yao, Xiaohang Yue, Samar K. Strategic inventory deployment for retail and e-tail stores[j]. The International Journal of Management Science, 008,(4): [3]. Forsberg R. Exact evaluation of (R,Q) policies for two-level inventory systems with Poissson demand[j].european Journal of Operational Research,999,96(3):30-38 [4]. Khoua J.Optimal ordering, discounting and pricing in the single-period problem[j].international Journal of Production Econoics,000,65:0-6 [5]. Qu Shoufeng. The Study on Out of Stock Control Model of Multi-echelon under Cyclical Demand[J]. Journal of Southeast University,007(8):p879~88,in Chinese [6]. Zhou Zhiping, Gao Peng. The Discussion about Inventory Control of Distribution Enterprises Based on Supply Chain Management[J].Chinese Management Science,004.0():p437~44,in Chinese 38