Inventory Replenishment System and its Strategic

Implications1

A continuous inventory replenishment model/policy taught in core operations

management course recommends the following rules:
Reorder Point (ROP) to trigger an order by a downstream player (customer) to its
immediate upstream partner (supplier) is when inventory position touches the
level equal to demand during lead time + safety stock (i.e. ROP = DLT + SS).
Where,
Lead time (LT) = time elapsed from placement of order to receipt of delivery
against it;
Demand during lead time (DLT) = Expected (forecasted avg) demand during
lead time;
Safety stock (SS) = z x (standard deviation of demand during lead time);
z is determined by the target service level (assuming normally distributed
demand);
Std.dev. of dem. during LT (SDDTL) = A measure of variability of demand
during lead time;
For the customer, Order Quantity should ideally be close to the EOQ level = { 2 x
OC x D / IC }1/2.
Here, D = Forecasted average daily demand;
OC = Avg cost incurred to place & ship an order (or average cost incurred in
each changeover or set-up);
IC = Inventory holding cost per unit per day; (if D is annual demand then IC is
per year too).
At the EOQ level, the sum of inventory carrying cost and ordering (or set-up) cost is
minimum for the agent (customer) placing the order.
A supply chain comprising manufacturers, depots, distributors and
retailers, serves a competitive consumer market. The market and
competitive pressure demand efficiency (i.e. fast deliveries or quick
inventory turnover), large variety of products/SKUs, high service level at
retail end (fill rate), and low cost-to-serve.
In this situation, the table below lists some interventions which a firm
could undertake in order to improve its performance in the market. For
each intervention, the table explains which of the parameters of inventory
1 Note prepared by Rahul Pandey (rahul.pandey@igsalabs.com) in 2014.

replenishment model it would impact and how. Also, it describes the

overall impact it would have on the ultimate KPIs of the firm: inventory
turnover, variety, service level, and/or cost-to-serve. Two examples have
been done for you. Can you think of more intervention examples?

Intervention (and its type:

structural or
infrastructural2)

Inventory model
parameter(s) impacted
and direction of impact
(increase / decrease)

Impact on ultimate
supply chain KPIs (or
operations strategy
tasks)

Invent or invest in
technologies/methods to
reduce set-ups
(changeovers) in production

EOQ decreases as OC falls in

production (production setup time); SS decreases as
SDDLT falls in production
(SDDLT falls due to
aggregation of demand
across more product
variants which a flexible
machine can handle)

Increase inventory
turnover, reduce cost
(inventory cost and fixed
overhead cost), and
increase production, while
offering larger variety of
products

SS decreases as SDDLT falls

(SDDLT falls due to removal
of false signals and
mitigation of bullwhip
effects); As a secondary
effect, EOQ too might
decrease slightly as OC falls
a bit (due to automated and
quick transmission or order
information)

Increase service level (fill

rates) (by planning w.r.t.
close to true demand and
tracking true fill rates),
decrease inventory cost
(due to reduction of
unnecessary stocks) and
hence increase inventory
turnover

Ex: SMED practice in

stamping/press facilities; or
flexible CNC m/cs; or jig-less
product design in machining or
assy operations (e.g. auto,
consumer durables industries);
or Flexible process facility (e.g.
pharma industry)
Type: Structural
Deploy technology to
reliably collect daily (or real
time) POS data and retail
orders and transmit it up the
supply chain
Ex: HUL or P&G (and some other
FMCG firms) use hand-held
devices with which sales
persons visit retailers and
collect/ record/ transmit daily
orders; Some retail chains (e.g.
Spencers or BigBazaar) record

2 A structural intervention is one which involves investing in physical choices like

locations and capacities or acquiring/selecting explicitly available resources from
the market like technologies, suppliers, and personnel with certain skills. In
contrast, an infrastructural intervention involves investing in building desired skills
(implicit knowledge) in-house among individuals and teams and directing them
toward certain improvement goals.

POS data
Type: Structural