SUPPLY CHAIN

MANAGMENT
Dr. Nguyen Thi Yen
Foreign Trade University
Email: yennguyen87@ftu.edu.vn
Phone: 0915529787
Assessment method
■ Class attendance and participation: 10%

■ Midterm test: 30%

■ End-of-module exam: 60%

■ Plus point: 10% of end-of-module exam for beer game’s winners

Objectives

■ Understanding the definitions of supply chain management

■ Defining key issues in SCM and how to approach these issues

■ Defining basic activities in SCM (purchasing, inventory,

warehousing, distribution, forecast,….)
 Resources

■ Sunil Chopra and Peter Meindl (2010)- Supply chain management:

strategy, planning and operation, Global edition

■ Joel D. Wisner, G. Keong Leong, Keah-choon Tan (5th edition 2018)

- Principles of supply chain management
Course Structure
■ Chapter 1: Overview of supply chain management
■ Chapter 2: Purchasing management
■ Chapter 3: Demand forecasting
■ Chapter 4: Inventory management
■ Chapter 5: Distribution and warehouse management
■ Chapter 6: Integration
CHAPTER 1 : OVERVIEW OF SUPPLY CHAIN
MANAGEMENT
You should be able to:
■ Describe a supply chain and define supply chain management.
■ Describe the objectives and elements of supply chain management.
■ Describe basic supply chain management activities.
■ Describe a brief history of supply chain management.
■ Describe the supply chain classification
■ Describe the supply chain strategies.

6
 What is a Supply Chain?
A supply chain consists of the flow of products and services from:
– Raw materials manufacturers
– Component and intermediate manufacturers
– Final product manufacturers
– Wholesalers and distributors and
– Retailers

Connected by transportation and storage activities, and

Integrated through information, planning, and integration activities
(Wisner et al, 2018)

7
 What is a Supply Chain? (continued)

8
 A basic supply chain

Supplier Producer Customer

■ Raw materials Components from supplier Received the finished goods

■ Energy Finished goods
■ Services Services
■ Components

9
■ “ A supply chain consists all parties involved, directly or indirectly,
in fulfilling a customer request. The supply chain includes not only
the manufactures and suppliers, but also transporters, warehouses,
retailers, and even customers themselves” (Chopra & Meindl, 2010)

■ A supply chain involves the constant flow of information, product,

and cash between different stages.

10
Information flow Product flow Financial flow

Invoice Materials Payments of products

Sales literature Components Supplies
Specification Services
Receipts Finished goods
Orders
Rules and Regulations

11
 What is Supply Chain Management?
The planning and management of all activities involved in sourcing and
procurement, conversion, and all logistics management activities … also
includes coordination with channel partners, which can be suppliers,
intermediaries, third party service providers, and customers.
Council of Supply Chain Management Professionals

The design and management of seamless, value-added processes across

organizational boundaries to meet the real needs of the end customer.
Institute for Supply Management
The design, planning, execution, control and monitoring of supply chain
activities with the objective of creating net value, building a competitive
infrastructure, leveraging worldwide logistics, synchronizing supply with
demand, and measuring performance globally.
Association for Operations Management

12
What is Supply Chain Management?
(continued)

■ Successful supply chain management requires high levels of trust,

cooperation, collaboration, and honest, accurate communications
– All participants in the supply chain benefit.
– Boundaries are dynamic and extend from “the firm’s suppliers’
suppliers to its customers’ customers (i.e., second tier suppliers and
customers).”
– Supply chains also include reverse logistics activities to handle
returned products, warranty repairs, and recycling.

13
Objective of supply chain management

■ Maximize the supply chain profitability

■ Reducing overall costs (inventory cost, purchasing cost,…) and meeting

the needs of customers

■ Sharing information between all partners in supply chain

14
Importance of Supply Chain Management

Firms with large system inventories gain the most from successful SCM
– Lower purchasing & carrying costs
– Better product quality
– Higher customer service levels
– Increased sales and profits

15
Importance of Supply Chain Management
(continued)

Firms using Supply Chain Management:

1. Start with key suppliers
2. Move on to other suppliers, customers, and logistics services
3. Integrate second tier suppliers and customers (second tier
refers to the customer’s customers and the supplier’s
suppliers)

16
Origins of Supply Chain Management

17
Origins of Supply Chain Management
1950s-1960s
U.S. manufacturers focused on mass production techniques as their
principal cost reduction and productivity improvement strategies
1960s-1970s
Introduction of new computer technologies lead to development of
Materials Requirements Planning (MRP) and Manufacturing
Resource Planning (MRPII) to coordinate inventory management and
improve internal communication

18
Origins of Supply Chain Management
(continued)

1980s-1990s
Intense global competition led U.S. manufacturers to adopt:
– Supply Chain Management (SCM)
– Just-In-Time (JIT)
– Total Quality Management (TQM)
– Business Process Reengineering (BPR)
– Customer Relationship Management (CRM)

19
Characteristics Logistics Supply chain management

Activities Transportation, warehousing, Logistics, supplier, manufacturing,

forecast, delivery, customer service, collaboration, integration, customer,…
information,…
Scope Internal Internal + external

Objective Reducing logistics cost, improving Reducing total cost, and increasing
customer service collaboration and integration.

Influence Short time Long time

20
Origins of Supply Chain Management (continued)

Today
Emphasis is being placed on the environmental and social impacts of supply
chains

– Sustainability - ability to meet the needs of current supply chain members

without hindering the ability to meet the needs of future generations
– Triple bottom line – taking care of people, planet and profits

21
Foundations of Supply chain management

22
 Supply chain classification
■ Collaborate supply chains

FOCUS Relationship Development ( close working

relationship for mutual gain)

VALUE ● Share information

PROPOSITION ● Strategic partnerships
● Joint product development
● Long-term stability
● Mutual trust

23
Lean supply chains

FOCUS High volume; Low variety; Low costs;

(Consistent response to largely predictable
demands)

VALUE ● Seek economics of scale

PROPOSITION ● Low-cost production and distribution
● High reliability

24
Agile supply chains

FOCUS Manage enterprises for responsiveness;

quick reactions; (rapid response to
unpredictable demand and supply conditions)

VALUE ● Fast decision-making

PROPOSITION ● Fast delivery; flexible scheduling;
● Rapid response in unpredictable conditions
● Available capacity

25
Agile vs Lean

Agile
Variability

Lean
Low High
Volume
Fully flexible supply chains

FOCUS Hedge and deploy resources (supplier-led

development and delivery of new ideas)

VALUE ● Meet unplanned/ unplannable demands

PROPOSITION ● Innovative solutions; delivered extra fast
● Extensive human intervention.

27
 Supply chain strategies

■ Push/pull strategies
■ Pull processes: execution is initiated in response to a customer order
(customer demand is known with certainty)(Make-to-order – MTO)
■ Push processes: execution is initiated in anticipation of customer order
(demand is not known and must be forecast) (Make-to-stock – MTS)

Pull or Push????

28
 Decision: push or pull?

■ Depends on the discrepancy of …

- How long the customer is willing to wait?
- Production system / supply chain lead time
■ Based on demand rate:
- Low volume items → MTO
- High volume items → MTS (economies of scale)

29
 Postponement
■ Ability of a SC to delay the differentiation or customization until closer to
the time the product is sold

30
■ Common components in the SC during push phase

■ Product differentiation as close to the pull phase as possible

■ Goal:

– Generic inventory (level decreased)

– Agility to respond to demand uncertainty.

– Ability to offer variants at lower cost

31
Current Trends in Supply Chain Management

- Supply Chain Analytics - examining raw supply chain data and reaching
conclusions or making predictions with the information
- Most companies are trying to improve their supply chain sustainability
performance

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End of Chapter 1

33
CHAPTER 2: PURCHASING MANAGEMENT
You should be able to:

■ Describe the role of purchasing and its strategic impact on an

organization’s competitive advantage.

■ Describe the traditional purchasing process, e-procurement, public

procurement, and green purchasing.

■ Analyze and evaluate sourcing decisions and the factors impacting

supplier selection, including outsourcing, make-or-buy, and break-even
analysis.

34
 Types of product
2. PURCHASING PROCESS Purchasing situation
Requirements and practices of
enterprises

i. Traditional/manual/paper-based process

ii. E-procurement

iii. Global purchasing

iv. Green purchasing/sourcing

2. PURCHASING
PROCESS

Purchasing Cycle
is used for buying a
particular part, product,
or service.

Schroeder & Goldstein (2016)

The Purchasing Process – Manual Purchasing
(older system)
Step 1- Material Requisition/Purchase Requisition –
Stating product, quantity, and delivery date. May originate as a planned
order release from the MRP system. Traveling requisition used for
recurring orders.
Step 2- The Request for Quotation (RFQ) –
Buyer identifies suppliers & issues a request for quotation (RFQ) for
routine items or a Request for Proposal (RFP) for highly technical
products. Supplier Development is used to develop supplier capabilities.
Step 3- The Purchase Order (PO) –
Is the buyer’s offer & becomes a binding contract when accepted by
supplier. When initiated by the supplier on their own terms, the document is
a sales order.
The Purchasing Process – Manual Purchasing
Suppliers Purchasing Storage/Warehouse Users/Requisition Accounting
START
Materials Materials
Requisition Materials Requisition
No
MR 1 Available? MR 1
MR 2 MR 2
MR 3
Yes

Issue PO
Materials
Requisition
Purchase Purchase MR 1
Order Order MR 2
PO 1 PO 1 Accounting
PO 2 PO 2
PO 3 MR 2 Information
MR File Issue for charging the
PO 4
Materials
Materials + appropriate
department
DO 3
DO 2

Delivery PO File
Order PO 3
DO 1 MR File
DO 2

MR 2

Ship
Materials
MR 2
DO 2 + Accounts Payable
PO 2
Materials Materials +
PO 2
Delivery
Order Delivery
DO 1 Order
DO 1
INV 2

Invoice
INV 1 Invoice
INV 1
 PR – Purchasing Requisition
Material requisition
Clearly state:
4 1. Information about products/materials requested to
purchase: product code, abbreviation or full name
of the product, product type, product color (if
needed),...
1 2 2. Quantity (state the unit)
3. Delivery time required
4. Purchase requisition date (will be used for
tracking and retrieving purchase information
loops from this date)
5. Approval signature or relevant departments (Law,
Technical, ...)
1 3
5 Price/Recommended supplier: can be stated or not
Note: Traveling-requisition: used for materials or goods
purchased frequently or in the past
Purchase Requisition (PR)
 4
3

5
1 2

Yêu cầu mua hàng - Purchase Requisition (PR)

 RFQ – Request for Quotation
▪ Use in case:
(1) the requested material is no
longer/not in stock;
(2) there is a list of suppliers that
provides the product but does not
meet the relevant requirements
(3) there are currently no suppliers on the
list of this business supplying this
item looking for a new supplier
▪ It can be through bidding (open or
closed), public bidding in newspapers or
sending bid letters to potential suppliers,
etc.
▪ Supplier will send quotation according to
the appropriate form: by email or by post
to Purchasing Dept.
Request for Quotation (RFQ)
 1
PO – Purchasing Order
State clearly:
6 1. Order number
7 2. Information about products/materials
8 requested to purchase: product code,
abbreviation or full name of the product,
product type, product color (if needed),...
2 5 3
3. Quantity (specify purchase unit)
4
4. Quality requirements
5. Price
6. Delivery time required legally
7. Delivery method binding
8. Delivery address document?
9. Order due date
10. Confirmation signature of superiors or
Purchase Order (PO) relevant departments (Law, Technical, ...)
Purchase Order (PO)
The Purchasing Process – e-Procurement
Electronic purchasing (E-procurement) is an integrated purchasing process that uses
information technology application tools, computers, the internet, etc. to perform
transactions between companies/enterprises and other customers. supplier.

An electronic purchasing system covers the processes involved in purchasing activities,

from identifying needs in the organization, to supplier selection, to payment execution,
to contract management, and to supplier management.
The Purchasing Process – e-Procurement
Differences between E-procurement and E-commerce

E-procurement usually includes purchasing processes between companies (buyers) and suppliers
(sellers), commonly used in industrial purchasing.
→ SRM

E-commerce usually involves the buying process between

consumers/retail customers (buyers) and companies/businesses
(sellers), often used in commercial purchases.
→ CRM
The Purchasing Process – e-Procurement
Step 1- Material user enters a purchase request
- Relevant information such as quantity and date needed.

Step 2- Purchase requisition approved and transmitted electronically to buyer

- At purchasing department (hardcopy or electronically).

Step 3- Buyer reviews requisition, assigns a preferred supplier from the e-

procurement database
- Product description, closing date, & conditions are given.

Step 4- Buyer reviews closed bids & selects a supplier

Example
The Purchasing Process – e-Procurement
(Continued)

Advantages of the e-Procurement System

– Time savings
– Cost savings
– Accuracy
– Real time use
– Mobility
– Trackability
– Management benefits
– Supplier benefits
Global Sourcing

Import Broker – Sales agent who performs transactions for a fee

(They do not take title to the goods)
Import Merchant – Buys and takes title to the goods and resells them
to a buyer
Tariff – An official list showing the duties, taxes, or customs imposed
by the host country on imports or exports
Non-tariff barriers – import quotas, licensing agreements, embargoes,
laws and other regulations imposed on imports and exports
Global Sourcing (continued)

Reasons for Global Sourcing –

Opportunity to improve quality, cost, and delivery performance

Potential Challenges –
Requires additional skills and knowledge to deal with
international suppliers, logistics, communication, political
environment, and other issues
Global Sourcing (Continued)

Issues for Global Purchasers

■ United Nations’ Contracts for the International Sale of Goods
(CISG)
– Terms of acceptance cannot be modified
■ Incoterms (commonly used term referring to the International
Commercial Terms - uniform rules that simplify international
transactions of goods with respect to shipping costs, risks, and
responsibilities of buyer, seller and shipper
Global Sourcing (Continued)

Countertrade – goods and/or services of domestic firms are

exchanged for goods and/or services of equal value or in
combination with currency from foreign firms
Countertrade can include:
■ Barter - complete exchange of goods or services of equal
value without the exchange of currency
■ Offset - exchange agreement for industrial goods or
services as a condition of military-related export
Global Sourcing (Continued)

Countertrade can include:

■ Direct Offset - involves coproduction, or a joint venture and
exchange of related goods or services
■ Indirect Offset - involves exchange of goods or services
unrelated to the initial purchase.
■ Counterpurchase - the original exporter agrees to sell goods
or services to a foreign importer and simultaneously agrees to
buy specific goods or services from the foreign importer
Green Purchasing

■ Green sourcing: not only finding new environmentally friendly technologies or

increasing recycled materials, but also helping to reduce costs in different ways,
including replacing some components. into products, reducing waste and using less
raw materials.
Invest on environment, and reduce the cost

Green purchasing is the first step of sustainability supply chain

4. Develop
6.
3. Field-visit to strategic
1. Identify the 2. Negotiate 5. Execute the Institutionalize
supplier site to sourcing for
opportunity with Suppliers strategic plan the sourcing
evaluate green
strategy
purchasing

component related to environment

6 steps process for greener purchsing

 INsourcing

3. DECISION: INSOURCING
OR OURSOURCING

OUTsourcing
Sourcing Decisions – The Make or Buy Decision
Outsourcing –
Buying materials and components from suppliers instead of
making them in-house. The trend has moved toward
outsourcing.
The Make or Buy decision is a strategic decision
Sourcing Decisions – The Make or Buy Decision
(Continued)

Reasons for Buying or Outsourcing

– Cost advantage – Especially for components that are non-
vital to the organization’s operations, suppliers may have
economies of scale
– Insufficient capacity – A firm may be at or near capacity
and subcontracting from a supplier may make better sense
– Lack of expertise – Firm may not have the necessary
technology and expertise
– Quality – Suppliers have better technology, process, skilled
labor, and the advantage of economy of scale
Sourcing Decisions – The Make or Buy Decision
(Continued)

Reasons for Making

– Protect proprietary technology
– No competent supplier
– Better quality control
– Use existing idle capacity
– Control of lead-time, transportation, and warehousing
costs
– Lower cost
 Make-or-Buy Break-Even Analysis
Phân tích điểm tới hạn

A business has to decide whether to manufacture it in-house or buy it out to get the
parts it needs. Demand for the year is 15,000 units.

o If outsource, the cost for the order is 500$, the purchase price is 7$/SP;

o If insource, the investment in machinery and equipment is $25,000 and the cost
of components is $5/product

Cost Insourcing Outsourcing

Fixed costs $25,000 $500
Variable costs $5/SP $7/SP
Annual Demand: 15,000 SP
Should businesses self-produce or buy outside?
 Assumptions
(1) All costs involved can be classified under either fixed or variable cost,

(2) Fixed cost remains the same within the range of analysis,

(3) A linear variable cost relationship exists,

(4) Fixed cost of the make option is higher because of initial capital
investment in equipment

(5) Variable cost of the buy option is higher because of supplier profits.
Sourcing Decisions – The Make or Buy Decision
(Continued)

The Make-or-Buy Break-Even Analysis

Meaning of Break-even Point

■ If the Demand < Break-even Point → Buy

■ If the Demand > Break-even Point → Make
Roles of Supply Base
Supply Base - list of suppliers a firm uses to acquire its materials, services,
supplies, and equipment
– Emphasis on long-term strategic supplier alliances, consolidating volume
into one or a few suppliers, resulting in a smaller supply base

Preferred suppliers provide:

– Product and process technology & expertise to support buyer’s operations
– Information on latest trends in materials, processes, designs, and the
supply market
– Capacity for meeting unexpected demand
– Cost savings due to economies of scale
Supplier Selection
The process of selecting suppliers, is complex and should be based on
multiple criteria:

– Product and process technologies – Order system & cycle time

– Willingness to share technologies & – Cost
information – Capacity
– Quality – Communication capability
– Reliability – Location
– Service
Example:
ATV, InC. assemble five different models of all-terrain vehicles (ATVs) from
various ready-made components to serve the Las Vegas, Nevada, market. The
company uses the same engine for all its ATVs. The purchasing manager,
Ms.Jane Kim, needs to choose a supplier for engines for the coming year. Due
to the size of the warehouse and other administrative restrictions, she must
order the engines in lot size of 1,000 each. The unique characteristics of the
standardized engine require special tooling to be used during the
manufacturing process. ATV agrees to reimburse the supplier for the tooling.
This is a critical purchase, since late delivery of engines would disrupt
production and cause 50 percent lost sales and 50 percent back orders of the
ATVs. Jane has obtained quotes from two reliable suppliers but needs to know
which supplier is more cost-effective. She has the following information:
Requirement 12,000 units
Weight 22 pounds
Order processing cost $125 per order
Inventory carrying cost 20 % per year
Cost of working capital 10% per year
Profit margin 18%
Price of finished ATV $ 4,500
Back-order cost $ 15 per unit backordered

The following freight rates from her carrier:

Truckload (TL>= 40,000 Lbs) = $0.8 per ton-mile
Less-than-truckload (LTL) = $1.2 per ton-mile
Note: per ton-mile = 2,000 Lbs per mile; number of days per year = 365
Two suppliers:
Unit price Supplier 1 Supplier 2

1 to 999 units/order $510.00 $505.00

1,000 to 2,999 units/order $500.00 $498.00

3,000+ units/order $490.00 $488.00

Tooling cost $22,000 $20,000

Terms 2/10 net 30 1/10 net 30

Distance 125 miles 100 miles

Supplier Quality Rating (defects) 2% 3%

Supplier Delivery Rating (late delivery) 1% 2%

Supplier Selection (Continued)

Total cost of ownership concept

Description Supplier 1 Supplier 2
1. Total Engine Cost 12,000 units x $500 $6,000,000.00 12,000 units x $498 $5,976,000.00

2. Cash Discount
n/30 $6,000,000 x 10% x 30/365 $49,315.07 $5,976,000 x 10% x 30/365 $49,117.81
1/10 N/A $5,976,000(10% x10/365+1%) $76,132.60
2/10 $6,000,000(10% x10/365+2%) $136,438.36 N/A
Largest discount ($136,438.36) ($76,132.60)

3. Tooling Cost $22,000.00 $20,000.00

4. Transportation Cost
125miles x 12,000units x 22lbs x 100miles x 12,000units x 22lbs
(22,000 lb LTL) $19,800.00 $15,840.00
$1.20/2000 x $1.20/2000

5. Ordering Cost 12,000 / 1,000 x $125 $1,500.00 12,000 / 1,000 x $125 $1,500.00

6. Carying Cost 1,000 / 2 x $500 x 20% $50,000.00 1,000 / 2 x $498 x 20% $49,800.00

7. Quality Cost $6,000,000 x 2% $120,000.00 $5,976,000 x 3% $179,280.00

8. Delivery Rating
Backorder (50%) 12,000 x 1% x 50% x $15 $900.00 12,000 x 2% x 50% x $15 $1,800.00
12,000 x 2% x 50% x $4,500 x
Lost Sales (50%) 12,000 x 1% x 50% x $4,500 x 18% $48,600.00 $97,200.00
18%

TOTAL COST $6,126,361.64 $ 6,265,287.40

How Many Suppliers to Use
Single sourcing - a risky proposition. Current trends favor a few sources.

Reasons Favoring a Single Reasons Favoring Two or

Supplier More Suppliers
▪ To establish a good ▪ Need capacity
relationship
▪ Spread risk of supply
▪ Less quality variability interruption
▪ Lower cost ▪ Create competition
▪ Transportation economies ▪ Information
▪ Proprietary product or process ▪ Dealing with special kinds of
purchases business
▪ Volume too small to split
Purchasing Organization
Purchasing Organization is dependent on many factors, such as
market conditions & types of materials required
– Centralized Purchasing – Single purchasing department
located at the firm’s corporate office makes all the
purchasing decisions

– Decentralized Purchasing - individual, local purchasing

departments, such as plant level, make their own
purchasing decisions
Purchasing Organization (Continued)

Advantages - Advantages - Decentralization

Centralization – Better knowledge of
– Concentrated volumes requirements
– Avoids duplication – Local sourcing
– Specialization – Less bureaucracy
– Lower transportation costs
– No competition between
units
– Common supply base
Purchasing Organization (Continued)

A hybrid purchasing organization

▪ Decentralized-centralized (large multiunit org)-
decentralized corporate and centralized at business unit
▪ Centralized-decentralized (large organization
w/centralized control) centralized large national
contracts at corporate level and decentralized items
specific to business unit
End of Chapter 2
Chapter 4: Inventory Management

■ Concepts and Tools of Inventory Management

■ Inventory system design

■ Dependent and Independent Demand

■ Inventory Models
Introduction
▪ Inventory can be one of the most expensive assets of an
organization
▪ Management must reduce inventory levels yet avoid stockouts
▪ Managing perishable inventory presents a unique challenge
▪ Excessive inventory is a sign of poor inventory management
▪ Excessive inventory adversely affects financial performance
Concepts and Tools of Inventory Management
▪ Primary functions of inventory are to –
– Buffer from uncertainty in the marketplace
– Decouple dependencies in the supply chain (e.g., safety stock)

▪ Four broad categories of inventories

– Raw materials- unprocessed purchase inputs
– Work-in-process (WIP)- partially processed materials not yet ready for sales
– Finished goods- completed products ready for shipment
– Maintenance, repair & operating (MRO)- materials & supplies used in producing
products (e.g., cleaners & brooms)
Concepts and Tools of Inventory Management
(Continued)

Inventory Costs
– Direct costs- directly traceable to unit produced (e.g., labor)
– Indirect costs- cannot be traced directly to the unit produced (e.g.,
overhead)
– Fixed costs- independent of the output quantity (e.g, buildings, equipment)
– Variable costs- vary with output level (e.g., materials)
– Order costs- direct variable costs for placing an order
– Holding or carrying costs- incurred for holding inventory in storage
– In mfg, setup costs are related to machine setups
 Holding cost
■ Holding costs are the costs incurred for holding inventory in storage.
■ The holding costs include handling charges, warehousing expenses,
insurance, shrinkage, pilferage, taxes, and the cost of capital.
■ H = kC ( k: holding rate, C: purchase cost per unit)
■ The fluctuations of inventory and the level of inventory turnover ratio will
impact on the holding cost.
■ How to minimize the holding cost?

78
 Ordering cost
■ Order costs are the direct variable costs associated with placing an order
with the suppliers

■ Order costs includes managerial and clerical costs for preparing the
purchase, as well as incidental expenses that can be traced directly to the
purchase.

■ How to decrease the ordering cost???

79
Stockout cost

■ Stock out cost is the cost of losing customer. Those costs may
include lost sales, backorder costs, expediting, and additional
manufacturing and purchasing costs.

■ Measuring the stock out cost is very important, it shows the cost
that the customers have to pay when the inventory is zero

80
Concepts and Tools of Inventory Management
(Continued)

ABC Inventory Control System

Determines which inventories should be counted & managed more
closely than others

▪ Groups inventory as A, B, & C Items

– A items are given the highest priority with larger safety stocks. A items account for
approximately 20% of the total items & about 80% of the total inventory cost
– B items account for the other about 40% of total items & 15% of total inventory
cost.
– C items have the lowest value and hence lowest priority. They account for the
remaining 40% of total items & 5% of total inventory cost.
Inventory system design
Vendor Managed Inventory (VMI)
■ “Transferring responsibility for retail store replenishment from the retailer to
the wholesaler or manufacturer” (Ackerman 1995)
■ “VMI is an example of how it is impossible to improve the efficiency of
material flows in a vendor/buyer partnership.
■ The supplier is given the task of keeping the warehouse of the wholesaler
stocked with the supplier’s products. Now the supplier can align his operations
with the needs of the retail trade” (Holmstrom, 1998)
■ Variations:
- VMI with consignment:
- VMI without consignment:
Benefits of VMI
Supplier Hub
 “Inventory management involves balancing product
availability, or customer service, on the other hand,….

…….with the costs of providing a given level of

product availability on the other”
Dependent & Independent Demand
Inventory management models –
Generally classified as dependent demand and independent
demand models

▪ Dependent Demand – internal demand for parts based on demand of the

final product in which parts are used

▪ Independent Demand – demand for end products & has demand pattern
affected by trends, seasonal patterns, & general market conditions
Replenishment for independent demand:
“when to order” decision
▪ When stocks are at a level that is able to satisfy demand, and until the
replenishment order is available.

▪ There are two methods:

- At a specific time period (ROP): the periodic review or the periodic inventory
time-based method; e.g. weekly at the time trigger

- At a specific remaining level of stock (ROL): continuous review or the perpetual

inventory action level method and the fixed order quantity method
Replenishment for independent demand:
“How much to order” decision

▪ The Economic Order Quantity Model

▪ The Quantity Discount Model
▪ The Economic Manufacturing Quantity Model
The Economic Order Quantity Model

Economic Order Quantity (EOQ) Model – quantitative decision model

based on the trade-off between annual inventory holding costs
& annual order costs

■ Seeks to determine optimal order quantity

■ Order Cost is direct variable cost associated with
placing an order. (Sometimes called setup cost)

■ Holding Cost is cost incurred for holding inventory in

storage. (Sometimes called carrying cost)
The Economic Order Quantity Model

▪ Assumptions of the EOQ Model

1. Demand must be known & constant
2. Order lead time is known & constant
3. Replenishment is instantaneous
4. Price is constant
5. Holding cost is known & constant
6. Ordering cost is known & constant
7. Stock-outs are not allowed
The Economic Order Quantity Model
Total Annual Inventory Cost (TAIC) formula
– TAIC = Annual purchase cost + Annual holding cost + Annual
order cost
– TAIC = APC + AHC + AOC = (R x C) + (Q/2 x (k x C)) + (R/Q x S)
Where
TAIC = total annual inventory cost C = purchase cost per unit
APC = annual purchase cost S = cost of placing one order
AHC = annual holding cost R = annual demand
AOC = annual order cost Q = order quantity
k = holding rate, where annual holding cost per unit = k x C
The Economic Order Quantity Model
■ Economic order quantity (EOQ):

Where:

2RS R: Annual Requirements

EOQ= -------- S: Setup cost

kC k: Holding rate

C: Unit cost
Exercise
■ The Las Vegas Corporation purchase a critical component from one
of its key suppliers. The operation manager wants to determine the
economics order quantity, along with when to reorder, to ensure the
annual inventory cost is minimized. The following information was
obtained from historical data:
Annual requirements (R) = 7,200 units
Setup cost ( ordering cost) (S) = $100 per order
Holding rate (k) = 20%
Unit cost (C) = $20 per unit
Order lead time (LT) = 6 days
Number of days per year = 360 days
 The Quantity Discount Model
■ The quantity discount model must consider the trade – off between
purchasing in larger quantities to take advantage of the price discount
and the higher costs of holding inventory.

Total annual inventory cost = annual purchase cost + annual holding cost
+ annual order cost

TAIC = APC + AHC + AOC = (R x C) + [(Q/2) x (k x C)] + [(R/Q) x S]

Steps

❖ Define the EOQ for each price level

❖ If the EOQ is not associated with the particular price level because the order
quantity may not lie in the given quantity range for that unit price change
the EOQ to the minimum quantity required to get a price discount

❖ Define total annual inventory cost for each EOQ

❖ The order quantity that yields the lowest total annual inventory cost is the
optimal order quantity
Example: Finding the optimal order quantity with
quantity discounts at Kuantan Corporation
■ The Kuantan corporation purchase a component from a supplier who offers
quantity discounts to encourage larger order quantities. The supply chain
manager of the company, Dr. Hadilan Wijaya Ibrahim, wants to determine the
optimal order quantity to minimize the total annual inventory cost. The
company’s annual demand forecast for the item is 15,000 units, its order cost is
$40 per order, and its annual holding rate is 25%. The price schedule is:
Order quantity Price per unit
< 1000 $ 5.00
1001 – 2000 $ 4.50
2001 and above $ 4.00
■ 1. What is the optimal order quantity?
■ 2. What is the minimum total annual inventory cost?
The economic Manufacturing Quantity Model (
EMQ) or production order quantity (POQ)
■ The EMQ relaxes the instantaneous replenishment assumption by allowing
usage or partial delivery during production.
■ Assumptions:
■ - The demand is known and constant
■ - order leadtime is known and constant
■ - Partial delivery
■ - Price is constant
■ - The holding cost is known and constant
■ - Order cost is known and constant
■ - Stockouts are not allowed.
The Economic Manufacturing Quantity Model (
EMQ) or Production Order Quantity (POQ)
▪ EMQ : Q
▪ Demand rate (demand per day) : D
▪ The production rate ( manufacturer’s production per day): P
▪ The inventory builds up at the rate of (P – D ) during the production period (Tp), and the
maximum inventory Q, so:
P = Q/ Tp, QM = (P – D) x Tp
Therefore:
QM = (P – D) x Q/P = PQ/P x DQ/P = Q (1 – D/P)
Hence, the average inventory, QM /2 = Q/2 (1 – D/P)
Total annual inventory cost = annual product cost + annual holding cost + annual setup cost
TAIC = APC + AHC + ASC = [RxC] + [Q/2 (1 – D/P) x k x C] + [R/Q x S]
■ TAIC = APC + AHC + ASC = [RxC] + [Q/2 (1 – D/P) x k x C] + [R/Q x
S]
■ TAIC min when [Q/2 (1 – D/P) x k x C] = [R/Q x S]

■ 2RS P
■ and the EMQ = x
■ kC P-D
 Example: calculating the EMQ at the
Lone Wild Boar Corporation
■ The Lone Wild Boar Corporation manufacturers a crucial component internally
using the most advanced technology. The operations manager wants to
determine the economic manufacturing quantity to ensure that the total annual
inventory cost is minimized. The daily production rate (P) for the component is
200 units, annual demand ( R) is 18,000 units, setup cost (S) is $ 100 per setup,
and the annual holding rate (k) is 25%. The manager estimates that the total
cost ( C) of a finish component is $ 120. It is assumed that the plant operates
year-round and there are 360 days per year.
Replenishment for dependent demand:
Material planning (MRP/MRP II)
▪ Material requirements planning (MRP) is a software-based production planning
and inventory control system that has been used widely by manufacturing firms for
computing dependent demand and timing requirements.

▪ It further involved into manufacturing resource planning ( MRP – II) by including

other aspects of materials and resource planning.

▪ MRP is used to calculate the exact quantities, need dates, and planned order
released for components and subassemblies needs to manufacture the final products
Example: MRP
Inventory at the start of week 1 800 units

Safety stock 100 units

Leadtime 2 week
Order units 600 units

Period 0 1 2 3 4 5 6 7 8

Gross requirement 210 250 300 300 300 250 200 180

Scheduled receipts

Projected on-hand 800

inventory

Planned order 0
release