Inventory Management

Crash Course on: Inventory Management Inventories today: a curse, a blessing, a must..? 1

Course programme: 1. Why do we keep inventories? 2. Typical demand classifications and analyses helpful in inventory management. 3. Why high quality forecasting is so important for inventory management? 4. Cost aspects of inventory management. 5. Material ecoupling Point - dependent and independent demands, deterministic and stochastic approaches to inventory management. 2

Course programme: 6. Calculation of safety and cycle stock. 7. Classical stock replenishment systems (Reorder Point and Cycle Review) and their typical combinations. 8. Safety stock in case of dispersed inventories (square-root law). 9. Information ecoupling Point concept and its role in reduction of stock levels. 10. Review of selected logistics concepts and solutions oriented on stock reduction/rationalisation. 3

Course programme: 1. Why do we keep inventories? 2. Typical demand classifications and analyses helpful in inventory management. 3. Why high quality forecasting is so important for inventory management? 4. Cost aspects of inventory management. 5. Material ecoupling Point - dependent and independent demands, deterministic and stochastic approaches to inventory management. 4

Crash Course on Inventories Why do we keep inventories? 5

Why do we keep inventories? Inventory (stock) - materials in a supply chain or in a segment of a supply chain, expressed in quantities, locations and/or values, not used at present, but kept for the future use (consumption/ /sale). Based on ELA Terminology 6

THROUGHPUT TIME IN A SUPPLY CHAIN Why do we keep inventories? 5% Utility value 95% Among others,? keeping inventories is also here. 7

Why do we keep inventories? Customer service - = Income Costs Profit Working capital Return on Investment Inventories 8

Why do we keep inventories? Income Costs Profit Customer service - = Working Assets capital Return on Investment Assests Inventories 9

Why do we keep inventories? Stock classification By type and position in a pipeline Materials stock (raw materials, components) Work-in-progress stock Finished products stock Spare parts and auxiliary materials stock 10

Why do we keep inventories? eliveries Production istribution Raw materials and components Raw materials and components Finished products Consumer goods Work-in-progress Work-in-progress Auxillary materials, spare parts 11

Why do we keep inventories? o you keep a stock of bread in your household? 12

Why do we keep inventories? o you keep a stock of bread in your household? 13

Why do we keep inventories? Stock classification By the reasons for keeping Cycle stock Safety stock Seasonal stock Speculation stock Strategic stock 14

Why do we keep inventories? Stock classification By rotation Fast moving (rotating) stock Slow moving (rotating) stock Not moving (rotating) stock Obsolete stock Emergency stock 15

Why do we keep inventories? Q Stock structure Cycle stock S C Safety stock S S Surplus stock S sp 16

Why do we keep inventories? Stock maintaining, replenishment and its quantity result from: uncertainty of real demand, uncertainty of real quantity, quality and timing of deliveries, seasonal access to some materials and goods, service level required by a customer, expected difficulties with an access to some goods (expected rise of prices), discounts offered for purchases of larger quantities, some technical and/or organisational conditions of deliveries. 17

Cycle stock: Lack of possibilities to fully synchronise supplies with consumption, Technical and/or organisational conditions (limitations), Economic incentives (discounts). Safety stock: Random fluctuations of demand, Forecast errors, Long replenishment lead times, Unpredictable delays, Required service level. Surplus stock: Why do we keep inventories? Miscalculation of factors influencing safety stock, Wrong estimation of the required service level, Excessive safety measures taken to avoid stock-outs. 18

Why do we keep inventories? So, is this good or bad to have inventories? Good, because they: Guarantee a continuous access to all kinds of goods when supplies are discontinues, Guarantee access to goods in periods when they are not available, Ensure required service level compensating random variations of demand, Ensure required service level compensating delays of deliveries random variations of replenishment lead time. Bad, because they: Take space (warehouses), Cost money (space, losses, capital); carrying stock may cost annually up to 30% of its value. 19

Course programme: 1. Why do we keep inventories? 2. Typical demand classifications and analyses helpful in inventory management. 3. Why high quality forecasting is so important for inventory management? 4. Cost aspects of inventory management. 5. Material ecoupling Point - dependant and independent demands, deterministic and stochastic approaches to inventory management. 20

Crash Course on Inventories emand analyses 21

emand analyses ABC analysis, XYZ analysis, Customer and supplier related analyses, Trends & Seasonality, Random deviations - demand profile, Life-cycle analysis, Identification of wild demand. 22

emand analyses - ABC classification No Item code No of used/sold items Unit price Value of used/sold items Cummulated value of used/sold items 1 10-01 15344 3,5 53 704,00 53 704,00 7,0% 2 10-02 23 76,1 1 750,30 55 454,30 7,2% 3 10-03 557 11 6 127,00 61 581,30 8,0% 4 10-04 1270 5,43 6 896,10 68 477,40 8,9% 5 10-05 7088 2,05 14 530,40 83 007,80 10,8% 6 10-06 278 20,66 5 743,48 88 751,28 11,6% 7 10-07 1513 2,53 3 827,89 92 579,17 12,1% 8 10-08 13 1178 15 314,00 107 893,17 14,1% 9 10-09 997 6,53 6 510,41 114 403,58 14,9% 10 10-10 8724 0,4 3 489,60 117 893,18 15,4% 11 20-01 1245 2,46 3 062,70 120 955,88 15,8% 12 20-02 7688 20,9 160 679,20 281 635,08 36,8% 13 20-03 679 6,2 4 209,80 285 844,88 37,3% 14 20-04 1190 5,14 6 116,60 291 961,48 38,1% 15 20-05 25799 0,89 22 961,11 314 922,59 41,1% 16 20-06 1409 32,6 45 933,40 360 855,99 47,1% 17 20-07 133 74,86 9 956,38 370 812,37 48,4% 18 20-08 799 15,34 12 256,66 383 069,03 50,0% 19 20-09 9887 9,3 91 949,10 475 018,13 62,0% 20 20-10 2234 2,40 5 361,60 480 379,73 62,7% 21 30-01 22 208,9 4 595,80 484 975,53 63,3% 22 30-02 12778 20,4 260 671,20 745 646,73 97,3% 23 30-03 79 63 4 977,00 750 623,73 98,0% 24 30-04 1313 9,92 13 024,96 763 648,69 99,7% 25 30-05 557 4,81 2 679,17 766 327,86 100,0% 23

Rules of the ABC analysis: o establish a criterion, o rank and sort assortment according to the established criterion, o calculate a total sum, o calculate cumulative sums, emand analyses - ABC classification o calculate percentage share of cumulative sums in the total sum, o assign to group A items responsible for 80% of the criterion value, to group B items responsible for further 15%, and the remaining items to group C. 24

emand analyses - ABC classification 80:20 20% 30-50% A B C 25

emand analyses - ABC classification 26

emand analyses ABC/XYZ classification 5 20-06 1409 32,6 45 933,40 612 936,90 80,0% 6 20-05 25799 0,89 22 961,11 635 898,01 83,0% 7 10-08 13 1178 15 314,00 651 212,01 85,0% 8 10-05 7088 2,05 14 530,40 665 742,41 86,9% 9 30-04 1313 9,92 13 024,96 678 767,37 88,6% 10 20-08 799 15,34 12 256,66 691 024,03 90,2% Price Z 10-08 30-04 Y X Quantity A B C 20-05 27

emand analyses - XYZ classification Price Z Y X Quantity 28

emand analyses - XYZ classification Price Z Y X Quantity 29

emand analyses - XYZ classification No Item code No of used/sold items Unit price Value of used/sold items Cummulated value of used/sold items Cumm. [%] 1 10-01 15344 3,5 53 704,00 53 704,00 7,0% 2 10-02 23 76,1 1 750,30 55 454,30 7,2% 3 10-03 557 11 6 127,00 61 581,30 8,0% 4 10-04 1270 5,43 6 896,10 68 477,40 8,9% 5 10-05 7088 2,05 14 530,40 83 007,80 10,8% 6 10-06 278 20,66 5 743,48 88 751,28 11,6% 7 10-07 1513 2,53 3 827,89 92 579,17 12,1% 8 10-08 13 1178 15 314,00 107 893,17 14,1% 9 10-09 997 6,53 6 510,41 114 403,58 14,9% 10 10-10 8724 0,4 3 489,60 117 893,18 15,4% 11 20-01 1245 2,46 3 062,70 120 955,88 15,8% 12 20-02 7688 20,9 160 679,20 281 635,08 36,8% 13 20-03 679 6,2 4 209,80 285 844,88 37,3% 14 20-04 1190 5,14 6 116,60 291 961,48 38,1% 15 20-05 25799 0,89 22 961,11 314 922,59 41,1% 16 20-06 1409 32,6 45 933,40 360 855,99 47,1% 17 20-07 133 74,86 9 956,38 370 812,37 48,4% 18 20-08 799 15,34 12 256,66 383 069,03 50,0% 19 20-09 9887 9,3 91 949,10 475 018,13 62,0% 20 20-10 2234 2,40 5 361,60 480 379,73 62,7% 21 30-01 22 208,9 4 595,80 484 975,53 63,3% 22 30-02 12778 20,4 260 671,20 745 646,73 97,3% 23 30-03 79 63 4 977,00 750 623,73 98,0% 24 30-04 1313 9,92 13 024,96 763 648,69 99,7% 25 30-05 557 4,81 2 679,17 766 327,86 100,0% 30

emand analyses - XYZ classification No Item code No of used/sold Value of used/sold Cummulated value Cumm. Unit price items items of used/sold items [%] 1 20-05 10-01 25799 15344 0,89 3,5 22 53961,11 704,00 53 704,00 7,0% 2 10-01 10-02 15344 23 76,1 3,5 531 704,00 750,30 55 454,30 7,2% 3 30-02 10-03 12778 557 20,4 11 2606 671,20 127,00 61 581,30 8,0% 4 20-09 10-04 9887 1270 5,43 9,3 916 949,10 896,10 68 477,40 8,9% 5 10-10 10-05 8724 7088 2,05 0,4 14 3 489,60 530,40 83 007,80 10,8% 6 20-02 10-06 7688 278 20,66 20,9 1605 679,20 743,48 88 751,28 11,6% 7 10-05 10-07 7088 1513 2,05 2,53 143 530,40 827,89 92 579,17 12,1% 8 20-10 10-08 2234 13 1178 2,40 15 5 361,60 314,00 107 893,17 14,1% 9 10-07 10-09 1513 997 2,53 6,53 36 827,89 510,41 114 403,58 14,9% 10 20-06 10-10 1409 8724 32,6 0,4 453 933,40 489,60 117 893,18 15,4% 11 30-04 20-01 1313 1245 9,92 2,46 133 024,96 062,70 120 955,88 15,8% 12 10-04 20-02 1270 7688 5,43 20,9 160 6 896,10 679,20 281 635,08 36,8% 13 20-01 20-03 1245 679 2,46 6,2 34 062,70 209,80 285 844,88 37,3% 14 20-04 1190 5,14 6 116,60 291 961,48 38,1% 15 10-09 20-05 25799 997 6,53 0,89 22 6 510,41 961,11 314 922,59 41,1% 16 20-08 20-06 1409 799 15,34 32,6 12 45256,66 933,40 360 855,99 47,1% 17 20-03 20-07 679 133 74,86 6,2 49 209,80 956,38 370 812,37 48,4% 18 10-03 20-08 557 799 15,34 11 12 6 127,00 256,66 383 069,03 50,0% 19 30-05 20-09 9887 557 4,81 9,3 91 2 679,17 949,10 475 018,13 62,0% 20 10-06 20-10 1554 278 20,66 3,45 5 743,48 361,30 480 379,43 62,7% 21 20-07 30-01 133 22 74,86 208,9 94 956,38 595,80 484 975,23 63,3% 22 30-03 30-02 12778 79 20,4 63 260 4 977,00 671,20 745 646,43 97,3% 23 10-02 30-03 23 79 76,1 63 14 750,30 977,00 750 623,43 98,0% 24 30-01 30-04 1313 22 208,9 9,92 13 4 595,80 024,96 763 648,39 99,7% 25 10-08 30-05 557 13 1178 4,81 152 314,00 679,17 766 327,56 100,0% 31

emand analyses - XYZ classification Basic parameters describing demand variability Mean (average) demand 1 2... n n Standard deviation ( ) 1 2 ( 2) n 2 1... ( n ) 2 Coefficient of variation 32

emand analyses - XYZ classification = 82,7 = 4,5 =0,055 33

= 4,21 = 2,07 =0,49 emand analyses - XYZ classification 35

emand analyses - XYZ classification Coefficient of variation as a criterion for the XYZ classification X Y Z 0,2 0,2 0, 6 0, 6 37

emand analyses ABC/XYZ classification A B C X Y AX Group High turnover in terms of value, high and even periodical consumption (daily, weekly demand). Highly reliable forecasts. AY Group High turnover in terms of value, high and even periodical consumption (daily, weekly demand). Less reliable forecasts (significant forecast errors). BX Group Medium turnover in terms of value, high and even periodical consumption (daily, weekly demand). Highly reliable forecasts. BY Group Medium turnover in terms of value, high and even periodical consumption (daily, weekly demand). Less reliable forecasts (significant forecast errors). CX Group Low turnover in terms of value, high and even periodical consumption (daily, weekly demand). Highly reliable forecasts. CY Group Low turnover in terms of value, high and even periodical consumption (daily, weekly demand). Less reliable forecasts (significant forecast errors). Z AZ Group High turnover in terms of value, high and even periodical consumption (daily, weekly demand). Very poor reliability of forecasts. BZ Group Medium turnover in terms of value, high and even periodical consumption (daily, weekly demand). Very poor reliability of forecasts. CZ Group Low turnover in terms of value, high and even periodical consumption (daily, weekly demand). Very poor reliability of forecasts. 38

emand analyses ABC/XYZ classification AX BX CX AY BY CY AZ BZ CZ 39

emand emand analyses trends and seasonality General pattern of a time series seasonality with a trend Seasonality Trend Year I Year II Year III Year IV Time 40

emand analyses Analysis of a demand variability and profiles 41

emand analyses variability and profiles = 82,1 = 4,5 =0,055 42

emand analyses variability and profiles 50 40 30 20 10 0 43

emand analyses variability and profiles 50 40 30 20 10 0 44

Frequency emand analyses variability and profiles 0,40 0,30 0,20 0,10 0 10 20 30 40 50 emand 45

= 82,1 = 4,5 =0,055 emand analyses variability and profiles 46

emand analyses - ABC classification = 40,9 = 9,4 =0,23 47

= 40,9 = 9,4 =0,23 emand analyses variability and profiles Normal distribution can be applied in the case of fast moving goods (groups X and Y) 48

emand analyses - ABC classification = 0,0385 = 0,197 =5,03 49

= 0,0385 = 0,197 =5,03 emand analyses variability and profiles Poisson distribution can be applied in the case of slow moving goods, where calculated average demand (for a chosen time unit) is equal to the square of the standard deviation 2. 50

emand analyses variability and profiles Poisson distribution = 0,0385 = 0,5 = 1,0 = 2,0 = 3,0 = 4,21 51

EMAN Phases: emand analyses variability and profiles Inventory management v. life cycle Introduction evelopment Saturation ecline Withdrawal TIME 52

emand analyses variability and profiles = 38,4; = 5,84 = 42,5; = 15,0 53

Course programme: 1. Why do we keep inventories? 2. Typical demand classifications and analyses helpful in inventory management. 3. Why high quality forecasting is so important for inventory management? 4. Cost aspects of inventory management. 5. Material ecoupling Point - dependant and independent demands, deterministic and stochastic approaches to inventory management. 54

Crash Course on Inventories Why high quality forecasting is so important for inventory management? 55

Basic forecasting models and techniques Inventory planning requires foreseeing future events, influencing processes which determine stock level: demand and its variability (trends, seasonality, random nature), changes of replenishment lead time and its variability, cost relationships. Foreseeing future events means: forecasting (based on formal procedures, formulas and algorithms), prediction (expert analysis). 56

Basic forecasting models and techniques Forecasting can be based on: internal data (e.g. historical data about sales of nutrients for infants), external data (e.g. demographical data regarding increase or decrease of births). 57

Basic forecasting models and techniques emand Random factor Seasonality Trend Year I Year II Year III Year IV time t 58

Basic forecasting models and techniques Selected forecasting metods Exponential smoothing Winter s model Seasonal coefficients model Analytical models Exponential smoothing Holt s model Exponential smoothing Brown model Weighted moving average Moving average Arithmetical average Econometric models Heuristic models Analog models Scenarios Simulations Shortterm forecasts Longterm forcests 59

Basic forecasting models and techniques Exponential smoothing all data considered in a forecast selection of the smoothing constant (0 < < 1) calculation of a forecast: k 1 k k k k 1 = 0 constant forecast model = 1 naive forecast k k (1 ) 60

Basic forecasting models and techniques 12 Exponential smoothing 0,0 10 8 7,00 6 4 2 0 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 k 1 k k k 61

Basic forecasting models and techniques How to assess forecast quality? Three areas of assessment: Quality of a forecast model Forecast accuracy Forecast acceptance 68 68

Basic forecasting models and techniques Quality of a forecast model t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 emand 120 132 141 150 159 166 173 181 184 190 195 199 206 210 215 220 223 230 233 236 70

Basic forecasting models and techniques etermination coefficient R 2 n t 1 n t 1 ŷ y t t y y 2 2 R 2 0,1 y t ŷ t y - real, historical value of the considered variable for the period t, - theoretical (model) value of the considered variable for the period t, - mean value of the considered variable for n periods. 71

Basic forecasting models and techniques Quality of a forecast model t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 emand 120 132 141 150 159 166 173 181 184 190 195 199 206 210 215 220 223 230 233 236 72

Basic forecasting models and techniques Forecast accuracy Today t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Forecast 50 49 48 50 52 53 52 54 54 54 54 54 50 46 48 47 44 43 46 47 emand 51 51 56 52 53 48 63 56 49 52 49 45 36 57 48 36 38 49 62 57 Forecast Real demand 74

Basic forecasting models and techniques Forecast accuracy ex post measures 1 Absolute forecast error ex post 2 Mean absloute forecast error ex post 3 Relative forecast error ex post e 0 Formula e t q t n t 1 y t y (y y t t t n y * t y y * t * t ) 100 4 Mean relative forecast error ex post 1 n n t 1 y t y t y * t 100 y t y t - real, historical value of the considered variable for the period t, - forcast value of the considered variable for the period t, 75

Basic forecasting models and techniques Forecast accuracy ex post measures Formula 5 Mean square error s * 1 n t n 1 (y t y * t ) 2 6 Mean absolute error (deviation) d i n 1 y t n y * t y t y t - real, historical value of the considered variable for the period t, - forecast value of the considered variable for the period t, s*,d min 76

Basic forecasting models and techniques How to assess forecast quality? Three areas of assessment: Quality of the forecast model Forecast accuracy Forecast acceptance 77

Basic forecasting models and techniques Forecast acceptance Today t 1 2 3 4 5 6 7 8 9 10 11 12 13 Forecast/model 37 38,8 40,6 42,4 44,2 46 47,8 49,6 51,4 53,2 55 56,8 58,6 emand 37 38 42 39 46 49 49 44 55 52??? Absolute forecast error ex ante Relative forecast error ex ante 2 (T t) 1 T s * 1 n t 2 n t 100 (t t) t 1 y * t 78

Basic forecasting models and techniques Forecast acceptance Today t 1 2 3 4 5 6 7 8 9 10 11 12 13 Forecast/model 37 38,8 40,6 42,4 44,2 46 47,8 49,6 51,4 53,2 55 56,8 58,6 emand 37 38 42 39 46 49 49 44 55 52??? Absolute forecast error ex ante Relative forecast error ex ante 2 (T t) 1 T s * 1 n t 2 n t 100 (t t) t 1 y * t 79

Basic forecasting models and techniques It has to be distinguished between a wrong forecast and a forecast error. What are the consequences of wrong forecasts (wrong forecast models)? Wrong safety stock levels: too high or too low, What are the consequences of high forecast errors? High safety stock levels. 80

Course programme: 1. Why do we keep inventory? 2. Typical demand classifications and analyses helpful in inventory management. 3. Why high quality forecasting is so important for inventory management? 4. Cost aspects of inventory management. 5. Material ecoupling Point - dependant and independent demands, deterministic and stochastic approaches to inventory management. 81

Crash Course on Inventories Cost aspects of inventory management 82

Cost aspects Replenishment costs (Cr) Carrying costs (Cc) Stock-out costs (Co) We can distinguish Fixed (independent) costs (Cr f, Cc f, Co f ) Variable (dependant) costs (Cr v, Cc v, Co v ) 83

Cost aspects Replenishment costs (Cr) fixed (independent) costs (Cr f ) fixed costs of a purchasing department and other departments responsible for receipts (rooms, media, salaries, overheads) fixed transport costs (fleet depreciation, salaries, overheads) 84

Cost aspects Replenishment costs (Cr) variable costs (dependent on a number of orders) (Cr v ) Order preparation costs, Quality control costs, Transport costs (fuel, maintenance), Custom clearance fees. 85

Cost aspects Replenishment costs (Cr) variable costs (dependent on a number of orders) over a given period (Cr v ) can be calculated by multiplying a unit cost related to a single order/delivery (c r ) and a number of deliveries (nd) realised in the period. Cr v c r nd 86

Cost aspects Carrying costs (Cc) fixed (independent) costs (Cc f ) epreciation and exploitation costs of a warehouse (building) epreciation costs of a warehouse equipment Salaries plus overheads 87

Cost aspects Carrying costs (Cc) variable costs (dependent on stock quantity) Cc v Cost of maintaining special storing conditions, Stock insurance costs, Cost of losses and stock depreciation, Cost of a tied-up capital (cost of credit or lost incomes from a deposit). 88

Cost aspects Carrying costs (Cc) variable costs (dependent on stock quantity) (Cc v ) over a given period depends on a storing period (time) and stock value (eg. purchase price). A unit inventory carrying cost can be calculated as: Cc v c c c c coefficient of periodical inventory carrying cost (c c = 0.05 0.20 per year) p u unit price p u 89

Cost aspects Stock-out costs (Co) fixed (independent costs (Co f ): Additional transport cost for emergency purchase, Fixed penalty fee paid to the customer, Permanent loss of a customer (loss of future incomes), Loss of the market reputation (temporary or permanent loss of a group of customers), Cost of stopping a production line. 90

Cost aspects Stock-out costs (Co) Variable costs (dependant on the shortage quantity) Co v Higher price for emergency purchase, Penalty fee based on number of missing items, Lost margin income due to particular transaction, Less margin income due to selling a substitute product, Cost of the postponement (transaction and payment postponed), Cost of lost production. 91

Course programme: 1. Why do we keep inventories? 2. Typical demand classifications and analyses helpful in inventory management. 3. Why high quality forecasting is so important for inventory management? 4. Cost aspects of inventory management.. 5. Material ecoupling Point - dependant and independent demands, deterministic and stochastic approaches to inventory management. 92

Crash Course on Inventories Material ecoupling Point dependent and independent demand 93

Material ecoupling Point elivery Production istribution Reaction time Lead time gap Customer order lead time Lead time gap Customer order lead time Lead time gap Customer order lead time Source: M. Christopher. Logistics and Supply Chain Management. Startegies for Reducing Costs and Improving Services. 1st edition. Financial Times. Prentice Hall 94

Material ecoupling Point Information (orders) elivery Inventory 95

Material ecoupling Point Information (orders) elivery Inventory 96

Material ecoupling Point elivery Production istribution 97

Material ecoupling Point elivery Production istribution ependent demand 5 4 3 2 Independent demand 1 98

Material ecoupling Point elivery Production istribution Residual stock ependent demand Cycle and safety stock of finished goods 2 Independent demand Calculations Material Requirements Planning Forecasts 99

Course programme: 6. Service level and safety stock. 7. Classical optimisation of the cycle stock. 8. Classical stock replenishment systems (Reorder Point and Cycle Review) and their typical combinations. 9. Safety stock in case of dispersed inventories (square-root law), 10. Information ecoupling Point concept and its role in reduction of stock levels. 11. Review of selected logistics concepts and solutions oriented on stock reduction/rationalisation. 100

Crash Course on Inventories Service level and safety stock 101

Service level and safety stock = 40,9 = 9,4 =0,23 102

Service level and safety stock 103

Service level and safety stock Knowledge of a demand distribution over a selected time unit (e.g. a day, a week) is very important. But this is not enough to manage inventories in a proper way. Stock replenishment is realised over a defined time period, called a replenishment lead time. It is very important to know this time. The key issue is the demand distribution over the replenishment lead time 104

Service level and safety stock emand distribution within replenishment cycle 105

Replenishment lead time Service level and safety stock Replenishment lead time the period of time between the moment the decision is made that a product is to be replenished and the moment the product is available for use. elivery lead time is the time between the receipt of the customer order and the delivery of the product to the customer and is always shorter then the replenishment lead time. 106

Service level and safety stock Replenishment cycle Replenishment lead time elivery cycle ecision on replenishment Placing an order Receipt of the order Starting production or picking the order Preparation for loading Loading Arrival to the customer (receiver) Approval of the delivery (quality control) Unloading Availability for use 107

Replenishment lead time Service level and safety stock The need for replenishment occurs The need is recognized ecision on replenishment Placing an order Receipt of the order Starting production or picking the order Preparation for loading Loading LT Arrival to the customer (receiver) Approval of the delivery (quality control) Unloading Availability for use 108

= 40,9 = 9,4 =0,23 LT=4 Service level and safety stock = 163,6 = 18,8 =0,121 109

Service level and safety stock ; Probability density functions LT LT; LT LT 0 20 40 60 80 100 120 140 160 180 200 220 240 260 280 110

Service level and safety stock istribution function Probability that demand over the replenishment cycle will not exceed the given level Probability density function 0 20 40 60 80 100 120 140 160 180 200 220 240 111

Service level and safety stock p( LT 195) 0,953 185 190 195 200 205 0 20 40 60 80 100 120 140 160 180 200 220 240 112

f() f(lt) f(t) 50 50 100 100 150 P 150 LT f( LT ) Normal distribution 340 500 660 LT 113

Service level and safety stock Service level 114

Service level and safety stock Suppliers Sevice Level indicators Time to inform about emergency situation, Relaibilty of deliveris (quality, quanitity, time), Flexiblity of deliveries (time, quantity) Avalibility of ordered raw materials and components Row materials and components Finished goods Customer oriented Sevice Level indicators Avalibility of goods Responsiveness to customer needs (flexibility). 115

Service level and safety stock Customer service level SL1 Probability of not getting out of stock (Probability that a stock-out situation will not occur over a replenishment lead time) 116

Service level and safety stock 220 How often? 200 180 160 LT 140 120 100 80 60 40 20 0 117

0,045 Service level and safety stock 0,04 0,035 0,03 0,025 0,02 0,015 0,01 0,005 Service level Probability of serving demand within replenishment cycle Stock-out probability within a replenishment cycle 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 LT Stock level at the beginning of a replenishment cycle 118

0,045 Service level and safety stock 0,04 0,035 0,03 0,025 0,02 0,015 Service level Probability of serving demand within replenishment cycle Stock-out probability within a replenishment cycle 0,01 50% 0,005 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 Stock level at the beginning of a replenishment cycle LT 119

0,045 Service level and safety stock 0,04 0,035 0,03 0,025 Service level Probability of serving demand within replenishment cycle Stock-out probability within a replenishment cycle 0,02 0,015 0,01 0,005 SL1 nd nd nd stock out 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 Stock level at the beginning of the replenishment cycle LT S S S s Safety stock LT 120

Service level and safety stock f(sl) SL 121

Service level and safety stock Stock level Variable demand [t] S S LT LT LT Constant replenishment cycle lead time LT LT 122

Service level and safety stock Stock level Constant demand LT LT S S [t] Variable replenishment cycle lead time LT 1 LT LT 123

Service level and safety stock Stock level Variable demand LT LT LT S S Variable replenishment cycle lead time LT 1 LT 2 LT 2 LT [t] 2 124

Service level and safety stock Customer service level SL2 Fill rate for customer orders (Probability of meeting the expected demand in terms of quantity) 125

Service level and safety stock 0,045 0,04 0,035 0,03 0,025 FR Q Q n sh How many units can be missing? What is the expected number of shorteges n sh? 0,02 0,015 0,01 0,005 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 LT Stock level at the beginning of the replenishment cycle 126

f() f(t) f(lt) 50 100 150 LT Real service level resulting from the assumtion that the demand distribution is compatible with the normal distribution. Expected service level Normalndistribution 340 500 660 LT 127

Service level and safety stock Safety stock (S S ) Average demand emand variability (forecast std. deviation) Replenishment lead time T Lead time variability LT Service level: probability of a no stock-out situation over a replenishment cycle (probability measure), demand (order) fulfilment (quantity measure). Cost based optimisation: safety stock carrying cost stock-out cost Strategic (tactical) decisions Intuitive, Casual. 128

Service level and safety stock S s C so Cc(S s ) v SL opt S s opt Q Cr v S r Cc(S r ) v Q opt S r opt TC = Cr f + Cc f + Cr v + Cc(S r ) v + Cc(S s ) v + C so Cost relationships in optimisation of safety stock 129

Service level and safety stock 1400,0 1200,0 Cost A sum of stock carrying and stock-out costs 1000,0 800,0 600,0 Stock carrying cost 400,0 200,0 Stock-out cost 0,0 90 91 92 93 94 95 96 97 98 99 Optimal serice level Opitmal safety stock SL [%] 130

Course programme: 6. Service level and safety stock. 7. Classical optimisation of the cycle stock. 8. Classical stock replenishment systems (Reorder Point and Cycle Review) and their typical combinations. 9. Safety stock in case of dispersed inventories (square-root law), 10. Information ecoupling Point concept and its role in reduction of stock levels. 11. Review of selected logistics concepts and solutions oriented on stock reduction/rationalisation. 131

Crash Course on Inventories Cycle stock optimisation 132

Cycle stock optimisation Q Q CS CS SS SS 133

Cycle stock optimisation S s C so Cc(S s ) v SL opt S s opt Q Cr v S r Cc(S r ) v Q opt S r opt TC = Cr f + Cc f + Cr v + Cc(S r ) v + Cc(S s ) v + C so Cost relationships in optimisation of cycle stock 134

Cycle stock optimisation A principle of calculating the Economic Order Quantity Variable cost of replenishment and carrying the cycle stock: Cr v Cc v p Q c r 0,5 Q p u c cp p forecast (planned) demand over a period p (eg. a year annual demand, Q order quantity c r - replenishment cost related to a single order/delivery p u unit price (or production cost per unit), c cp inventory cost carrying coefficient for a period p. 135

Cycle stock optimisation C O S T Cc v Cr v EOQ Economic Order Quantity Q 136

Cycle stock optimisation Economic Order Quantity EOQ 2 p u p c c cp r 137

Course programme: 6. Service level and safety stock. 7. Classical optimisation of the cycle stock. 8. Classical stock replenishment systems (Reorder Point and Cycle Review) and their typical combinations. 9. Safety stock in case of dispersed inventories (square-root law). 10. Information ecoupling Point concept and its role in reduction of stock levels. 11. Review of selected logistics concepts and solutions oriented on stock reduction/rationalisation. 138

Crash Course on Inventories Basic replenishment systems 139

Basic replenishment systems S U P P L I E R Orders ecisions Stock emand fluctuations C U S T O M E R Lead time distribution emand distribution 140

Basic replenishment systems There are two basic replenishment (ordering) systems: Replenishment system based on a reorder level (BQ) variable replenishment periods safety stock: when to order? fixed order quantity Replenishment system based on a periodic review (ST) variable order quantity safety stock: how many (how much) to order? fixed replenishment periods 141

Basic replenishment systems Replenishment system based on a reorder level (when to order?) 142

Basic principles and rules: fixed quantity of orders and deliveries (Q = const) variable replenishment period (t) current knowledge of the economic stock (S e ) calculated reorder level (order point B) B = LT + S S (S S = (LT)) an order is placed whenever the economic stock falls below the reorder level: S e B Basic replenishment systems Replenishment system based on a reorder level 143

Basic replenishment systems Replenishment system based on a reorder level Economic stock = = Physical stock + quantity of that product ordered but not yet received quantity of that product already reserved 144

Basic replenishment systems Replenishment system based on a reorder level Safety stock: S (SL) s LT I.If 0 and LT 0 then : LT LT II.If LT 0 and 0 then : LT LT III. If 0 and LT 0 then : LT 2 LT 2 LT 2 145

Basic replenishment systems S T O C K Replenishment system based on a reorder level Variable demand B LT LT LT S s Variable replenishment lead time LT 1 [t] 146

Basic replenishment systems Replenishment system based on periodic review (how much to order?) 147

Basic principles and rules: fixed review and replenishment period (T o =const) variable quantity of orders and deliveries (Q) current knowledge of the economic stock (S e ) calculated maximum level S Basic replenishment systems Replenishment system based on a periodic review S = LT+T o ) + S S (S S = (LT)) an order quantity is calculated as: Q= S-S e 148

Basic replenishment systems Replenishment system based on a periodic review Safety stock: S (SL) s LT I.If 0 and LT 0 then : LT LT T 0 II.If LT 0 and 0 then : LT LT III. If 0 and LT 0 then : LT 2 (LT T 0 ) 2 LT 2 149

Basic replenishment systems Replenishment system based on a periodic review S T O C K S Variable demand LT T 0 LT [t] T 0 LT T 0 S s 150

Basic replenishment systems Alternative (hybrid) replenishment systems 151

Basic replenishment systems Review period (Tr) Order period (T 0 ) Order quantity (Q) Reorder level (B/s) (A) BQ fixed fixed Maximum level (S) (B) ST fixed fixed fixed (C) BS fixed fixed () sq fixed fixed fixed (E) ss fixed fixed fixed 152

BQ Basic replenishment systems Q Q Q B LT LT LT Reorder level based system (a lot of small orders) 153

ST Basic replenishment systems S LT LT LT LT LT T 0 T 0 T 0 T 0 T 0 Periodic review 154

BS Basic replenishment systems S B LT LT LT Recommended in the case of relatively small number of big orders (MIN-MAX) 155

sq Basic replenishment systems Q Q Q s LT LT LT T 0 T 0 T 0 T 0 T 0 Fixed cycle of possible orders of fixed quantity 156

ss Basic replenishment systems S LT LT LT s T 0 T 0 T 0 T 0 T 0 Small number of big orders fixed review cycle 157

Crash Course on Inventories Safety stock in case of dispersed inventories (square-root law) 159

1,40 1,20 1,00 0,80 0,60 0,40 0,20 0,00 1,60 1,40 1,20 1,00 0,80 0,60 0,40 0,20 0,00 1,40 1,20 1,00 0,80 0,60 0,40 0,20 0,00 1,60 1,40 1,20 1,00 0,80 0,60 0,40 0,20 0,00 1,60 1,40 1,20 1,00 0,80 0,60 0,40 0,20 0,00 ispersed inventories 1 2 3 4 100 units; 1 1 1 1 20 units 1,40 1,60 1,20 1,40 1,00 1,20 0,80 1,00 0,80 0,60 0,60 0,40 0,40 0,20 Regional Warehouse 1 Regional Warehouse 2 0,20 0,00 0,00 1,60 1,60 1,40 1,40 1,20 1,20 1,00 1,00 0,80 0,80 0,60 0,60 0,40 0,40 0,20 Regional Warehouse 3 Regional Warehouse 4 0,20 0,00 0,00 160

161 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 1,60 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 1,60 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 1,60 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 ispersed inventories Central warehouse

162 2 2 2 2 2 RWN RW3 RW2 RW1 MC... N 3 2 1 RW RW RW RW MC... ispersed inventories 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 1,60 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 1,60 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 1,60 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40

If: ispersed inventories RW 1 RW 2 RW 3... RW N RW 2 2 2 MC... RW1 RW2 2 RW3 2 RWN 2 RW then: CW N RW 2 CW N 2 RW N MC RW 163

ispersed inventories 2 RW1 2 CW... RW1 2 RW1 2 RW1? S s LT LT S SCW S 2 S RW1 S 2 S RW 2 S 2 S RW 3... S 2 S RWN 164

Crash Course on Inventories Information ecoupling Point 166

Information ecoupling Point Information (orders) elivery Inventory 167

Information ecoupling Point = 38,4; = 5,84 = 42,5; = 15,0 168

Solutions oriented on stock reduction 6. Service level and safety stock. 7. Classical optimisation of the cycle stock. 8. Classical stock replenishment systems (Reorder Point and Cycle Review) and their typical combinations. 9. Safety stock in case of dispersed inventories (square-root law). 10. Information ecoupling Point concept and its role in reduction of stock levels. 11. Review of selected logistics concepts and solutions oriented on stock reduction/rationalisation. 171

Solutions oriented on stock reduction Q Stock structure Cycle stock S C Safety stock S S Surplus stock S sp 172

Safety stock Solutions oriented on stock reduction Revision of service levels ABC/XYZ/CAV analysis Shorter replenishment cycles S S 2 LT 2 LT 2 Fewer delays Forecats Centralised stock 173

Solutions oriented on stock reduction C S 1 2 Forecats 1 EOQ 2 2 p u o c c co r Reduction of replenishment costs. Improvements of ordering process. Cycle stock Reduction of inventory carrying costs. 174

Solutions oriented on stock reduction EOQ S C C S EOQ 2 1 2 2 o p c u c co r S S S S 2 LT 2 LT 2 175

Solutions oriented on stock reduction Just-in Time JiT Quick Response QR Efficient Consumer Response ECR Vendor Managed Inventory VMI Co-managed Inventory CMI Collaborative Planning, Forecasting and Replenishment CPFR 176

Solutions oriented on stock reduction Just-in-Time C S EOQ 2 1 2 2 o p c u c c o r S S 2 LT 2 LT 2 177

Solutions oriented on stock reduction Qiuck Response C S EOQ 2 1 2 2 o p c u c c o r S S 2 LT 2 LT 2 178

Solutions oriented on stock reduction Collaborative Planning, Forecasting and Replenishment C S EOQ 2 1 2 2 o p c u c c o r S S 2 LT 2 LT 2 179

Solutions oriented on stock reduction Continous replenishemnt C S EOQ 2 1 2 2 o p c u c c o r S S 2 LT 2 LT 2 180

Solutions oriented on stock reduction Vendor Managed Inventory Co-Managed Inventory C S EOQ 2 1 2 2 o p c u c c o r S S 2 LT 2 LT 2 181

Solutions oriented on stock reduction Performance measures stock controll Stock cover: Stock turnover: SCO S STO S 182

Solutions oriented on stock reduction Last year This year Sales (demand) - 475 560 Average stock level - S 31 35 475 S 31 475 9,13 SCO 3, 39 STO 15, 3 52 9,13 S 31 560 52 10,77 S 35 560 SCO 3,25 STO 16 10,77 S 35 183

Crash Course on inventorises. Inventories Today Thank you for your attention! Inventories today: a curse, a blessing, a must..? In a way INEVITIBILITY, but... don t let them get out of control! 184

1. o you keep in your household a stock of: Summary of the questionnarie 185

Summary of the questionnarie 1. In case of permanent stock is it high or low level stock? 186

Summary of the questionnarie 2. Please indicate three most important reasons for keeping inventories in your company: 187

Summary of the questionnarie 3. Which, in your opinion, would be the most effective ways to reduce stock levels in your company? 188

Summary of the questionnarie 4. What are the most critical barriers for implementation of solutions leading to stock reduction in your company? 189

Contact: stanislaw.krzyzaniak@ilim.poznan.pl mateusz.boruta@ilim.poznan.pl Instytut Logistyki i Magazynowania (Institute of Logistics and Warehouisng) Poznań - POLAN www.ilim.poznan.pl Tel. +48-61-852-98-98 190