Inventory Management Review

Postponent Calculations Part I: Before Postponement

I recently encountered a postponement/pooling issue that I thought I'd make an example out of.  The following problem explains how postponement can result in pooling for a product with a steady lead time, known average demand, and known standard deviations of that demand.  In other words, you know exactly how long it takes you get it and you have a very good idea as to how many you will sell.

Products
There are two main products.  The DD1 and the DD2.  The DD1 has a production time of 19 days with an average daily demand of 1,000 and a daily standard deviation of 180 units.  The DD2 has a also has a 20 day production time,  average weekly demand of 1,200 and standard deviation of 200 units.  We want to find out what the optimal safety stock levels should be.  Both products have a 98% service level set.

Formula
If you recall, the safety stock formula has two terms.  The first term is the cycle stock and second term is the safety stock.  We are only going to look at safety stock (choosing to ignore cycle stock because this model has little affect on the cycle stock investment).  The term in the inventory equation for safety stock can be rearranged so variations in lead time are not taken into account, which is perfect for this example because lead times are constant.  The following formula is that variation:

Safety Stock=z*standard deviation*SQRT(Lead Time)

z is a statistical tool used to correllate service level with standard deviations.  In order to find a z-value for a 98% service level, use the following formula in Excel:

=NORMSINV(98%)

This equals 2.05

Now we have the inputs we need for our safety stocks:

DD1 Formula Inputs

z=2.05

STDEV=180 Units

Lead Time=20 days (this is the production time and in considered the lead time because it is the time it takes to make more units if all units in production run out).

SS=2.05*180*SQrt(60)=1653 Units

DD2 Formula Inputs

z=2.05

STDEV=200

Lead Time=20 days

SS=2.05*200*SQRT(20)=1836 Units

Total safety stock inventory is 3,490 units (sum of DD1+DD2)

This is localized optimization for inventory without postponement.  The next post will discuss the inventory model when postponement is put into place.

Make Time to Re-Order

Chances are, you're pretty busy at work.  You've got the boss giving you more work than you actually have time to get done, customers and vendors calling you throughout the day and your email box filling up faster than you can read it.  Despite all of this, you've gotta take a 1-hour lunch break, right?  Well before you take that break (and I am NOT about to tell anyone not to take a nice long lunch) and before you get all of that other work taken care, ask yourself, "is it time to re-order?"

If the answer is yes, DO IT.  If your firm's main source of revenue is from the sale of physical goods, then you absolutely, positively need to make sure that those goods are readily available.  Yes, failure to reorder will lower your average inventory, but this is not the way to do it.   A shortage of inventory can cause many costs.  Not to mention, think of all the work your firm did to develop the original product, and now all you need to do is place an order.

Essentially, as busy as things can get at work, just try to remember that re-ordering is one of the most essential parts of your business.  You can invest all the money you want into inventory software packages, but at the end of the day, you still need to re-order.  Re-ordering on time is such an integral part of business that large firms automate the reordering process using EDI.

Chances are, EDI may not be for you.  Putting into place the needed personal to ensure prompt re-ordering may be a more appropriate course of action.  What I mean by this, is that if the person in charge of re-ordering is very busy with other work, then maybe it's time to find someone else to deal with the orders, because if you don't re-order, you can't sell, and tracking the status of backorders for a small business is no picnic either.  Believe me, it's easier to make time to re-order than it is to be forced to make time to deal with backorders.

So, do what you've got to do, but just make sure of two things: re-order, and take an hour long lunch.  If your boss is pissed about the Pinsky file not being completed, at least you've got a warehouse properly stocked and a full stomache, and really, what more can you ask for?

Keep Vendors Happy, Keep Inventory Low

When you get down to it, there are two main goals to inventory: keep the inventory levels low and the service level high.  Past articles on this site explain these principles in more detail including mathematical principles detailing how to find the optimum balance of service level and inventory levels for your company

A large contributor to keeping inventory low and service high is the lead time for specific materials.  If you can obtain more stock quickly, you can order in a hurry if you need to.  Although there are many ways to keep lead times low, failure to keep vendors happy is a quick way to keep lead times high.  Higher lead times means higher inventory, means more money thrown out the window to holding costs.

Pay your bills
For the same reasons you want to take care of your reliably paying customers first, your vendors want to take care of their reliable customers first.  If this can be you, you can expect your lead times to drop and potentially receive discounts from your suppliers.   Most suppliers have good customers and bad customers.  The good ones should be rewarded.

If you don't pay your bills, you might have to switch suppliers fairly frequently.  This can very substantially raise your lead times and results in switching costs.  In the short-run it may seem simpler to blow off a few bills, but believe me, unpaid bills are not worth the headache.  In addition to inventory level issues, unpaid bills can be a nightmare for an accounting department dealing with collection calls.  If you can't pay them, work with your vendors.  Whatever you do, keep your suppliers happy.