Tuesday, February 12, 2013

Discussion on Key concepts of Inventory Management: 1 Model, 2Demands, 3 Costs and 5 Inventories

After reading the Passage Managing Inventories-Reorder Point System, I summarised 2 Demand, 3 Cost, 5 Inventory and 1 Model.

The Inventory management is about how to forecast demand and integrate the supply chain to make it more effective and lower the cost. In order to reach this goal, we have to make clear the constraints and method. In this blog, I would like to discuss the key concepts and introduce 1 Model to calculate the proper quantity of the inventory.

Firstly , I ‘d like to introduce those key concepts involved with assumption and constraints.

2 Demands: forecast demand and required demand
  Forecast Demand: coming from customer, distributor and service part, while the required demand coming from fixed clients’ orders. Our model are based on the latter one.

Our goal is to meet the fluctuation demands.

3 Costs:
  Ordering Cost: The cost to make the order, like labor cost for the negotiation, paper cost and so on.
  Carrying Cost: The cost in transportation.
  Holding Cost: The cost in Maintenance
Our Goal is to reduce the 3 costs.

5 Inventories:
Cycle Stock Inventory: The average stock in fiscal period ( Involved Quantity discount realized)

Pipeline Inventories: Time delays in producing, handling and distributing product

Safety(Buffer) Sock Inventory: to make the inventory able to meet fluctuated market demands and therefore no stocking out happens, it’s a kind of redundancy, but also offers responsiveness
Seasonal(Anticipation) inventories: Adjust inventory according to seasonal change or anticipation
Speculation inventories: Buy inventories in case of the big fluctuation of price in the inventory in short time.

The goal here is to find the way to manage the five inventories.                          

One Model:
Finally I'd like to introduce a simple and useful math model from the reading material on cost analysis, how to make the right order to make the cost smallest under certain amount Annual Requirement, Carrying cost per unit, ordering cost and holding cost in proportion with carrying cost.

We assume the Annual Requirement R, Each order Q, carrying cost C/unit , Ordering cost S, K is a fraction of the Inventory holding cost to carrying cost.
We got the following formula:

          Annual Cost=R/Q*(S+C*Q)=R*S/Q+R*C+K*C*Q/2
                  ACmin when Q*Q=2*R*S/KC
                       Q=Square Root(2*R*S/KC)

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