Variability

The Bull Whip Effect A Vicious Cycle Build-to-Order, Lean, JIT, Managing Variability: A different view of inventory

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Example
Procter & Gamble: Pampers Smooth consumer demand Fluctuating sales at retail stores Highly variable demand on distributors
Wild swings in demand on manufacturing Greatest swings in demand on suppliers
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Illustration

Consumer Sales at Retailer

1000

Consumer demand

900 800 700 600 500 400 300 200 100 11 13 15 17 19 21 23 25 27 29 31 33 35 37 37 39 39 41 41 3 1 5 7 9 0

Retailer's Orders to Distributor

1000 900

Retailer Order

800 700 600 500 400 300 200 100 11 13 15 17 19 21 23 25 27 29 31 33 35 1 3 5 7 9 0

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Illustration

Retailer's Orders to Distributor

1000 900

Retailer Order

800 700 600 500 400 300 200 100 33 35 37 39 11 13 15 17 19 21 23 25 27 29 31 41 41 1 3 5 7 9 0

Distributor's Orders to P&G

1000

Distributor Order

900 800 700 600 500 400 300 200 100 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 1 3 5 7 9 0

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Illustration

Distributors Orders to P&G

1000

Distributor Order

900 800 700 600 500 400 300 200 100 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 1 3 5 7 9 0

P&G's Orders with 3M

1000 900 800 700

P&G Order

600 500 400 300 200 100

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13 10 16 19 22 1 4 7

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37

25

28

31

40

Illustration

Consumer Sales at Retailer

1000

Consumer demand

900 800 700 600 500 400 300 200 100 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39

37

P&G's Orders with 3M

1000 900 800 700

P&G Order

600 500 400 300 200 100 34 13 10 16 19 22 25 28

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40

0 1 4 7

41

What Are the Effects?

What problems, costs, challenges does this create for the players in the supply chain? What problems does this create for the product in the market place?
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Forecasting
More variability

Poorer forecasts

Less reliable supply

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Causes of Bullwhip Today

Product Proliferation/Mass Customization
More varieties of products

Build-to-Order
Prohibits pooling orders to smooth requirements

Lean
Prevents pooling releases to smooth demand on the supply chain
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Why Lean (Just-In-Time)?

Reduces inventory
Capital requirements Etc

Reduces handling
Direct-to-Line

Improves Quality
See problems quickly

Increases launch speed

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Why Not Lean?

Capacity Changes in requirements create upstream inventory Changes in requirements raise transport costs Reliability Distant suppliers subject to disruption

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Release Variability

Daily Receipt
1400

1200

1000

800

600

400

200

0 01-Apr-02 06-Apr-02 11-Apr-02 16-Apr-02 21-Apr-02 26-Apr-02

Managing Variability
Capacity Buffer Inventory Buffer Time Buffer

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Freight Cost
Required rate of conveyances

Capacity

Utilized Capacity
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Time

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Expediting
Required rate of conveyances

Expedited Service

Lower Capacity

Utilized Capacity

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Time

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Ideal Supply Chain

Same requirements every day
No excess capacity
No inventory
No service failures
Minimum Cost

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Buffer Inventory with

Constant Supply
Variation in Demand

Volume
Variation in Buffer
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Time

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A Financial Model From Revenues Cash Expenses

Cash Acct

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A Financial Model From Revenues Cash Expenses

Invest

Sell Assets Cash Acct

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Controls
Invest enough to bring it to here When Cash balance reaches here

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Controls

Sell assets to bring it to here When Cash balance falls to here

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Controls

T t b

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Trade-offs

Opportunity cost of Cash Balance Transaction costs of investing and selling assets Set the controls, T, t and b to balance these costs

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Inventory Analogy
Cash Expenses From Revenue Sell Assets Invest Excess Daily Production reqs.
Constant supplies
Expedited order
Curtailed order

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Trade-offs

Opportunity
cost of Cash
Balance Transaction costs of investing and
selling assets
Cost of
holding
Inventory Supply chain costs of expediting and curtailing orders Set the controls, T, t and b to balance these costs
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The Traditional Model

1

1-(p1+ q1) p1

p2

pk
k

qk

q1

q2

A Markov Model

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Challenges
Data intensive: pis and qis Computationally intensive Alternative
Brownian motion
Inventory behaves like
a random walk Model of a particle in space

Two parameters: mean and variance Advanced calculus methods make it easy to work with

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Release Variability

Daily Receipt
1400

1200

68% of time usage is between 0 and 800

1000

800

= 412 = 367
06-Apr-02 11-Apr-02 16-Apr-02 21-Apr-02 26-Apr-02

600

400

200

0
01-Apr-02

The EOQ as a Special Case

Average usage rate Variance in usage 2 Nominal release rate < Since we order less than we consume, inventory drifts downward How much should we expedite when it reaches 0?
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Trade offs

Expediting disrupts the supply chain

Fixed cost F for each time we expedite Variable cost f for each item in the order holding cost h for inventory

Larger orders mean less frequent but

larger disruptions and more inventory

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EOQ as Special Case

Order Q Time between orders is Q/( ) Order frequency is ( )/Q Average Inventory is Q/2 + 2/2( ) Average Cost is
Expediting Cost: Inventory Cost: (F+fQ)( )/Q h(Q/2 + 2/2( ))
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The Total Cost Formula

hQ/2 + F( )/Q + h2/2( ) + f( )

EOQ: Transaction EOQ: Inventory Constant that doesnt depend on Q

The best Q balances inventory and ordering costs: hQ/2 = F( )/Q Q2 = 2F( )/h Q = 2F( )/h
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Fixed Expediting Quantity

Find the best nominal release rate to get the right frequency of expediting

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The Total Cost Formula

hQ/2 + h2/2r + fr + Fr/Q

EOQ: Inventory Constant that doesnt depend on r EOQ: Transaction

The best drift rate r = balances inventory and ordering costs: h2/2r = fr + Fr/Q r2 = h2Q/2(F+fQ) r = h2Q/2(F+fQ)

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Two-sided Version

If inventory grows too large, curtail shipments Whats too large? How much should we curtail? If expediting is expensive
create a positive drift order more than you need curtail shipments when inventory is too high
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Differences

Constant Stream of Releases punctuated by Expediting and Curtailing If supplier can see inventory,
can anticipate expedited and curtailed orders

Have to set a lower bound > 0 to protect against disruptions safety stock

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100

150

200

250

300

50

0 1 8 15 22 29 36 43 50 57 64 71 78 85 92 99 106 113 120 127 134 141 148 155 162 169 176 183 190 197 204 211 218 225 232 239 246

Example: Shipments

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Example: Inventory

1000 900 800

700

600

500

400

300

200

100

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