Welcome back, in this course of supply chain
analytics, so far we have discussed about various types of forecasting models which
we used for taking decision with respect to planning of various activities in the supply
chain. In our last session we also started one very
important issue in the supply chain that is inventory management. Inventory management is a subject which most
of us have studied in the classes of operations management, but inventory management when
we study only for a standalone entity. That inventory management is very different
type of inventory management. In case of supply chains where various entities
are linked with one another, inventory management alone can make or destroy your supply chain
decisions. So, it is very important in a supply chain
case, that we take very appropriate decisions with respect to inventory management. Obviously, the feeding, the input for taking
decisions with respect to inventory is provided by the forecasting. That is why we discuss forecasting in the
beginning of these various decision making activities. Now, we are into this inventory management,
and in operations management class I expect that most of us have already studied, various
different types of inventory management models. Now, we will see here, in this particular
course that how we can extend those inventory management models in a supply chain environment. Supply chain environment when I say, it is
being characterized by having different types of entities in your supply chain. This is a very simple case, we started with
in our last session, that here we have 2 installations. In this supply chain we have 2 installations,
installation1, and installation 2. In installation1 you can say can be the wholesaler,
installation2 can be retailer, or installation1 can be a manufacturer and installation 2 can
be a retailer directly. So, just to start the discussion that how
do we move from our conventional inventory management where we discuss only a particular
installation. In that case in a conventional system we consider
only a particular station and we manage the inventory only for one single entity. Here, if we do that, means if we start managing
the inventory separately for these different entities. We will lose the very essence of supply chain
management. So, therefore it is important that we should
consider, that whatever decisions are taken. This should be taken in the interest of entire
supply chain. Right from the day 1 when we started this
course, we are talking continuously about collectivism about taking decision where we
can take the interest of entire supply chain. And, therefore we will use principles of or
the formulas or the models developed for single installations. But, here we will extend them in a supply
chain environment. So, to start that case, we are taking only
2 installations as I just explained. Now, in case of this particular model we can
understand, that there are different type of relations between 1 and 2. But, one thing is very interesting, we all
can easily appreciate that if 1 is a wholesaler, 2 is a retailer. If 1 is a manufacturer, 2 is a retailer, if
1 is a supplier of some type of raw material, 2 may be the manufacturer. So, what I am trying to say that as we move
from this side to this side in a supply chain. As I am moving from left to right in a supply
chain. I am adding more value to my product, and
therefore many times supply chains are also known as value chains. Because, with our formal movement with our
movement from left to right we are adding value to our products. And, therefore supply chains are the value
chains and as I am adding value to my product from left to right the correspondingly the
unit cost of the product also increases, because of the value addition. So, if you remember in our conventional model
of inventory management. We use to have 2 important variable cost. And, you can recall that these 2 important
cost are, one is order cost, and the second is holding cost. These are the 2 important cost, which we consider
in our most popular inventory management model that is EOQ model. That is Economic Order Quantity Model. In that EOQ model we consider these 2 types
of cost. Now, the holding cost, I will like to emphasise
on. The holding cost is that cost when you are
keeping inventory with you, you incur some type of cost on keeping that inventory. And, that cost may come from variety of sources. For keeping some items in your stock, you
have taken a warehouse on rent. So, that rent which you are paying for keeping
the inventory may go for this holding cost. You are paying for the security of the item,
some type of insurance premium. That insurance premium will also be the part
of the holding cost. Then, there will be some kind of opportunity
cost also. You have blogged your capital in keeping the
inventory, and as a result of that you are losing some other opportunities of using that
capital, so that is also added in to the holding cost. So, holding cost may come from variety of
sources. And, therefore holding cost is always you
must have learned in operation management classes. That holding cost is always represented as
a percentage of the total material cost. The cost of the material which you are buying
for which you are keeping the inventory. So, it is always represented as a percentage
of that material cost. The order cost or in some literature you will
also find the name setup cost. So, the setup cost or the order cost. This setup cost results because of a your
receiving the order, whenever you give an order, so the setup cost will come, because
there will be some kind of loading, unloading, some kind of communication involved. So, these are the order cost. Whenever in a plant you are working, and whenever
you are changing from one product to another product. So, you need to change your tools, so, you
need to change your dyes, and all those things. And, as a result of that we call it setup
cost. So, like just to explain these 2 costs more
clearly to you. Let us take an example in that example I want
to drink, cold drink after my dinner daily. And there are 2 possibilities. One possibility that I take my scooter and
after dinner daily I go to a general store, take one cold drink. So, that is one way of keeping the low inventory. So, whenever I require on a daily basis I
go to a general store take a cold drink. On the other hand I can also do that in one
go I can purchase the entire carat of the cold drinks. Maybe of 12, maybe of 20, and then I consume
these cold drinks one by one daily, and I need not to visit that general store again
and again on the daily basis, for next 10, 12, or 15, 20 days. So, in that case going to that general store
and coming back, the amount of fuel that I am consuming that will go to the order cost. And, since I am not keeping any cold drink
in my stock, so holding cost is absolutely 0 in this case. On the second criteria, when I am purchasing
the entire carat for the cold drink, for let us say one month stock. So, I need to go to that general store, to
purchase cold drink only once. So, my ordering cost has reduced substantially
here. I am paying the ordering cost only once, and
the holding cost has increased tremendously now. Because, I have kept the stock of 30 cold
drinks with me in one go. So, I have paid some 200 rupees or like that
for that purpose, and for that purpose my 200 rupees is blocked. I cannot use that money for any other activity,
and it is also possible that in this leakagement takes place. Some wear and tear may take place, so I may
loss my one cold drink, so that loss will also come into the holding cost. So, I have to take a call, I have to be optimum
that my ordering cost and holding cost should have some kind of balance, and when I achieve
that balance these 2 extreme situations I discussed. In one case I have only ordering cost, no
holding cost. And, in other case I have very low ordering
cost almost negligible, and my holding cost is very high. So, I want to have a balance between these
2 types of cost. So, that is what we do in our inventory management
systems. And, this very beatifically we have already
learn in our operation management class using the EOQ formulas. Economic Order Quantity formulas we have already
learned. So, now we will apply the same knowledge in
this particular case. Now, as I was mentioning about the holding
cost. Holding cost normally we represent with h. So, whatever we are doing for installation1,
we will use subscript one for that purpose. And, whatever we will do for installation2. We will use subscript 2 for that purpose. So, we have the holding cost at installation
1 as h1, and holding cost at installation 2 as h2. These are the 2 holding cost we are already
incurring. Now, because as we are coming from left to
right, as I said we are adding more value to our products. So, product is more valuable from 1 to 2. And, since holding cost is paid on the material
value of the product. So, always and always you can understand that
h2 , h2 because, it is on the right side of installation1, so h2 will always be greater
than 1. You can understand why h2 will always be greater
than h1. Because, h2 you have added more value by the
time product reaches this stage 2, installatiion2. You have added more value to that product,
and therefore h2 will be more than h1. Then another important thing is we have also
discussed there will be the order cost. So, order cost let us represent as k. So, there are ordering cost at installation
1 as k1 and order cost at installation2 as k2. These are our ordering cost. Now to further understand that how EOQ model
will operate, because now we are going to the stage of making the model for these 2
stage inventory management. And, for that purpose in our last class, we
discussed this particular graph where we had the system of inventory management like this. You are procuring or at a time you are giving
order of Q1 items at stage1, and Q2 items at stage 2. Now, Q2 item you have received here, we discussed
you received Q2 here, and the installation2 let us say is retailer. So, the rate of consumption of these Q2 item
is being represented by this slanted line. This slope line represents the rate of consumption
of these Q2 items. Then after sometime this Q2 item will finish. And you will have 0 inventory level. So, this is the point where we achieve the
0 inventory level, but because of our modelling, because we know many things we have already
ordered in advance that by the time you go to this 0 level. You get a fresh stock of Q2 items. And all of a sudden as soon as you are touching
this 0 level your new stock comes and your inventory level again reaches to the original
Q2 level. So, this vertical line represents the replenishment
of the stock. So, if I say in this particular graph if you
see in this particular graph we have these types of curves. So, these lines which are straight lines,
these are the replenishment lines. And, the slanted lines, these lines are the
consumption line these lines represents the rate of consumption of your Q2 stocks. This is the Q2 level, and these slope lines
are the consumption line. So, we have planned in such a manner. That if I am going to have my 0 inventory
on let us say 30th of January. So, immediately on the same date I will receive
the fresh supply of Q2 items. So, that my replenishment line shows that
instantaneously my stock will again go to the original Q2 level. So, the time, and for that purpose if this
is the time I am going to receive fresh the supply. So, I somehow order at this point. Here I have ordered this is time order placed. And, this is the time order received. The difference between these 2 times, when
I am placing the order and when I am receiving the order, this difference is known as lead
time. The time between placing an order and receiving
the supply, so I already know about my suppliers, that what is the lead time. My supplier, my predecessor can supply me
in 2 days, 3 days, 5 days, 7 days, 15 days I know the capability of my supplier. And accordingly I decide the lead time if
my supplier can supply in 5 days. So, I will know that after 5 days my stock
is going to be 0. So, I will give my order 5 days before. If my supplier take 7 days, so I know that
after 7 days my stocks will go to 0 level. So, I need to order 7 days before. So, as per the capability of your supplier,
as per the lead time they take to supply the product I decide the date of placing the order. Nowadays because of influence of Japanese
manufacturing systems in various domain of operations management, and so on in case of
supply chain management also. More and more companies, more and more supply
chains are looking to reduce this lead time. And there is a concept coming and many of
you may be aware also, that we want to have 0 lead time. We want to achieve the 0 lead time also in
our supply chains. And, if we achieve that 0 lead time, that
today I order, and immediately I got the supply, that is just in time. As soon as I require the product I immediately
get it. So, we are continuously looking to shorten
the lead times and, for that purpose it is very much important to develop the capabilities
of my supply chain partners. In such a way that they can supply me with
minimum possible lead time. Because, of so much volatility, because of
so much uncertainty, because of so much complexity, ambiguity. Because, of all these reasons I do not want
to keep long lead times. Things may change all of a sudden, and if
I have already place some order, and today I do not want, because the things have changed. So my supplier will force me to honour the
orders. But, if lead time is small, I can give order
only when it is required. So, it is the capability of the entire supply
chain. That we need to develop for reducing this
lead time. So, these system is there, and this system
which is being represented here also is known as saw teeth pattern of inventory management. Shows, sawteeth type of management between
the replenishment lines and the consumption lines. So this is the sawteeth type of pattern and
whenever you this sawteeth pattern. At that time you can apply EOQ model of inventory
management, or you can say also that sawteeth pattern enables you to apply EOQ model of
inventory management. So, now at installation 2, it is very clearly
visible that I can apply the EOQ model. But, now let us come to installation1. At, installation1, because installation1 is
responsible for supplying products to installation2. All the supplies to installation2, that come
from installation1. Now, therefore for better inventory management
what we have done that whatever supplies we are getting at installation1. Or whatever we are producing at installation
1. From that whenever we receive a new supply,
a part of that goes to installation2. And, we are left with some less amount of
inventory. And, that is what we have exactly made on
this graph. Here what we have taken that this at installation
1, the items which we are procuring these are Q1, and installation 1. Just for the sake of understanding, we normally
need to have and you will soon understand, that the item which we are procuring at installation
1. I am telling you a very simple relation between
what we are procuring at installation1 and, what we are procuring and installation number
2. There is a simple relationship between the
quantities which we want to procure at installation1 and installation2. Now at installation2 we are procuring Q2 items
and it is very simply now clear to us that you can apply the EOQ model to determine the
values of Q2. Now what to do with Q1 and what is this N
here. For this purpose just for the understanding
purpose we have taken, n equals to take 3, and equals to 3, and therefore Q1 becomes
3 Q2. We are procuring 3 Q2 at installation1. So this is the Q1 we procure whenever we order
this size of Q1 and out of that whenever I receive a supply of Q1 immediately Q2 supplies
go to the installation2. So I am left with Q1-Q2, and I will continue
with Q1-Q2 for some period. Then in a mean time at a installation2 these
Q2 items are finished. So I am left with Q1 - Q2 here, so I will
supply again Q2 items from this Q1 - Q2 to installation2. So, I am left with Q1-2 Q2 this and then after
sometime these Q2 items at installation2 are also finished. So, I am left with then I will supply remaining
Q2 also and I am left with zero inventory. I have no inventory at installation 1, so
this is the zero level from this period to this period there is no inventory at installation
1. Then again after sometime installation2 requires
Q2 items, so what I have done. I have adjusted my procurement cycle at installation
1, in such a manner that whenever there is a fresh requirement of Q2 items at installation
1 only then I will procure Q1 items at installation1. And, like this in this particular case when
these Q2 items are required here. So I am procuring again Q1 items here, So
you see where my finger is. The tip of my finger represents the Q1 a stock
and the out of an Q1 stock again I have supplied Q2 stocks to installation2. And I am left with this much that is Q1- Q2
and again the same process will be repeated this step process is repeated. Now, it is simple to see that at installation
2. You have the sawteeth pattern at installation1,
you have this type of a step pattern of inventory management. So, at installation1 we do not have the system
of EOQ, because of sawteeth pattern is not available there. But then there comes a new concept that is
the concept of Echelon stocks. So, for we discussed only about installation
stocks, that, whatever inventory is available at this particular installation, installation1,
installation2. So, whatever inventory is available at installation2,
I am discussing about that only. So, these thick lines are representing that
installation a stock. But, now we are going to introduce the new
concept that is Echelon stock. Now, Echelon stock is that when I am in the
supply chain environment, so whatever inventories are available at this stage, and all downward
stages all right stages in my supply chain, put together at a particular time that is
known as Echelon stock. So, in these particular cases only two stocks
are there. So whatever inventory is available at installation2
that installation stock as well as Echelon stock is same. Because, there is no right side entity in
this particular case. In case of 1 since right side is 2, so the
Echelon stock will be whatever, is available at 1+ whatever is available at 2 at a particular
time. So by this new definition we have a very interesting
thing that if you see on a particular time of starting time of a new cycle that day of
a starting time of a new cycle. Let us on this very first day So, you have
the physical stock and installation 1that is Q1- Q2. And, physical stock at the next stage at installation2
is Q2. So, total a stock on the day 1 becomes Q1-
Q2+ Q2 that is Q1 this point the top point of this curve. Then, we are continuously consuming these
items and at this particular time or at this particular time you see your total stock is
Q1-2Q2. And, what is there 0, so you have this much
inventory available in your total stock. Here installation 1 + installation 2. At this particular point you have 0 inventories
here, as well as 0 here also. 0 here and 0 here so 0 + 0 becomes 0 here. So, in a 3 cycles of installaton2, first cycle,
second cycle, and three cycle, so in these 3 cycles the inventory at installation 1,
has moved Echelon inventory at installation 1 has move from Q1 to 0. And, similarly if you see other cycles also,
the same pattern will be repeated, and when I join this Q1 point which is physically not
there. But, now since we have the concept of Echelon
stock. So, this Q1 can be become conceptualized. And, this dotted line which is joining Q1
to 0. And you can see this dotted line will pass
from these corner points of the steps, and this dotted will be followed in subsequent
replenishment cycles also. And, then you can see that these dotted lines
are also making a sawteeth pattern at installation1. And therefore we can apply EOQ model at installation
1 also. So, we stop here, in this session here, and
in next class we will see that how this EOQ model will be applied at stage 1, and stage
2 of the inventory management. Thank you very much.
