Centralization and ROP. A key component has a cost c = 10, holding cost h (for the period) = 1, salvage value v = 10, and sales price p = 19. What is the optimal target inventory level at each WH? What is the total inventory?. Warehouse A. Warehouse B. Demand N~(100,10^2).
Both warehouses have identical service levels
To provide desired SL, each location must carry Isafety = zσLTD
z is determined by the desired service level
The total safety inventory in the decentralized system is
Decrease in safety inventory by a factor of
LTDC = LTD1 + LTD2 LTDC = LTD + LTD = 2 LTD
Centralization reduced the safety inventory by a factor of 1/√2
GE lighting operating 7 warehouses. A warehouse with average lead time demand of 20,000 units with a standard deviation of 5,000 units and a 95% service level needs to carry a safety inventory of
Isafety = 1.65×5000= 8250
Independent demand in N locations: Total safety inventory to provide a specific SL increases not by N but by √N
Centralization of N locations:
If centralization of stocks reduces inventory, why doesn’t everybody do it?
These disadvantages my reduce the demand.
No Correlation: ρ close to 0
Positive Correlation: ρ close to 1
Perfect Positive Correlation: ρ = +1
Negative Correlation: ρ close to -1
Perfect Negative Correlation: ρ = -1
The safety inventory in the two-location decentralized system is larger than in the centralized system by a factor ofCorrelation
If demand is positively fully correlated, ρ = 1, centralization offers no benefits in the reduction of safety inventory
Benefits of centralization increases as the demand on the two locations become negatively correlated. The best case is = -1, where we do not need safety inventory at all
Virtual Centralization: inventory pooling in a network of locations is facilitated using information regarding availability of goods and subsequent transshipment of goods between locations to satisfy demand.
Less than Available stock
1. Information about product demand and availability must be available at both locations
2. Shipping the product from one location to a customer at another location must be fast and cost effective
Pooling is achieved by keeping the inventories at decentralized locations.
Both locations keep average inventory.
Safety inventory is kept only in the specialized warehouse
One other possibility to deal with variability is product substitution.
Levers for Reducing Safety Capacity