Inventory Systems

Managing Economies of Scale in a

Supply Chain: Cycle Inventory
• Balance the appropriate costs to choose the optimal lot size and
cycle inventory in a supply chain.
• Understand the impact of quantity discounts on lot size and cycle
inventory.
• Devise appropriate discounting schemes for a supply chain.
• Understand the impact of trade promotions on lot size and cycle
inventory.
• Identify managerial levers that reduce lot size and cycle inventory
in a supply chain without increasing cost.
 Role of Cycle Inventory
in a Supply Chain

• Lot or batch size is the quantity that a stage of a supply chain

either produces or purchases at a time

• Cycle inventory is the average inventory in a supply chain due to

either production or purchases in lot sizes that are larger than
those demanded by the customer
Q: Quantity in a lot or batch size
D: Demand per unit time
Inventory Profile
Role of Cycle Inventory in a
Supply Chain

lot size Q
Cycle inventory = =
2 2

average inventory
Average flow time =
average flow rate

Average flow time

resulting from cycle cycle inventory Q
= =
inventory demand 2D
 Role of Cycle Inventory in a
Supply Chain

• Lower cycle inventory has

Shorter average flow time
Lower working capital requirements
Lower inventory holding costs

• Cycle inventory is held to

Take advantage of economies of scale
Reduce costs in the supply chain
 Role of Cycle Inventory in a
Supply Chain

• Average price paid per unit purchased is a key cost in the lot-
sizing decision
Material cost = C

• Fixed ordering cost includes all costs that do not vary with the size
of the order but are incurred each time an order is placed
Fixed ordering cost = S

• Holding cost is the cost of carrying one unit in inventory for a

specified period of time
Holding cost = H = hC
 Role of Cycle Inventory in a
Supply Chain

• Primary role of cycle inventory is to allow different stages to

purchase product in lot sizes that minimize the sum of material,
ordering, and holding costs

• Ideally, cycle inventory decisions should consider costs across the

entire supply chain

• In practice, each stage generally makes its own supply chain

decisions

• Increases total cycle inventory and total costs in the supply chain
 Role of Cycle Inventory in a
Supply Chain

• Economies of scale exploited in three typical situations

A fixed cost is incurred each time an order is placed or
produced
The supplier offers price discounts based on the quantity
purchased per lot
The supplier offers short-term price discounts or holds trade
promotions
Estimating Cycle Inventory Related Costs
in Practice

• Inventory holding cost

Obsolescence cost
Handling cost
Occupancy cost
Miscellaneous costs
 Theft, security, damage, tax, insurance
Estimating Cycle Inventory Related Costs
in Practice

• Ordering cost
Buyer time
Transportation costs
Receiving costs
Other costs
Economies of Scale to Exploit Fixed Costs

• Lot sizing for a single product (EOQ)

D = Annual demand of the product
S = Fixed cost incurred per order
C = Cost per unit
H = Holding cost per year as a fraction of product cost

• Basic assumptions
Demand is steady at D units per unit time
No shortages are allowed
Replenishment lead time is fixed
Economies of Scale to Exploit Fixed Costs

• Minimize
Annual material cost
Annual ordering cost
Annual holding cost
Lot Sizing for a Single Product

Annual material cost = CD

D
Number of orders per year =
Q
æ Dö
Annual ordering cost = ç ÷ S
èQø
æQ ö æQö
Annual holding cost = ç ÷ H = ç ÷ hC
è2ø è2ø
æ Dö æQ ö
Total annual cost, TC = CD + ç ÷ S + ç ÷ hC
èQø è2ø
Lot Sizing for a Single Product
 Lot Sizing for a Single Product

• The economic order quantity (EOQ)

2DS
Optimal lot size, Q* =
hC

• The optimal ordering frequency

D DhC
n* = =
Q* 2S
 EOQ Example

Annual demand, D = 1,000 x 12 = 12,000 units

Order cost per lot, S = $4,000
Unit cost per computer, C = $500
Holding cost per year as a fraction of unit cost, h = 0.2

2 ´12,000 ´ 4,000
Optimal order size = Q* = = 980
0.2 ´ 500
 EOQ Example

Q * 980
Cycle inventory = = = 490
2 2
D
Number of orders per year = = 12.24
Q*

D æQ *ö
Annual ordering and holding cost = S +ç ÷ hC = 97,980
Q* è 2 ø
Q* 490
Average flow time = = = 0.041= 0.49 month
2D 12,000
 EOQ Example

• Lot size reduced to Q = 200 units

D æQ *ö
Annual inventory-related costs = S +ç ÷ hC = 250,000
Q* è 2 ø
 Lot Size and Ordering Cost

• If the lot size Q* = 200, how much should the ordering cost be
reduced?

Desired lot size, Q* = 200

Annual demand, D = 1,000 × 12 = 12,000 units

Unit cost per computer, C = $500

Holding cost per year as a fraction of inventory value, h = 0.2

hC(Q*)2 0.2 ´ 500 ´ 2002

S= = = 166.7
2D 2 ´12,000
 Production Lot Sizing

• The entire lot does not arrive at the same time

• Production occurs at a specified rate P
• Inventory builds up at a rate of P – D

2DS
QP =
(1– D / P)hC

Annual setup cost Annual holding cost

æ D ö æQP ö
ç P ÷S (1– D / P) ç ÷ hC
èQ ø è 2 ø
 Aggregating Multiple Products
in a Single Order

• Savings in transportation costs

Reduces fixed cost for each product
Lot size for each product can be reduced
Cycle inventory is reduced

• Single delivery from multiple suppliers or single truck delivering

to multiple retailers

• Receiving and loading costs reduced

 Lot Sizing with Multiple
Products or Customers

• Ordering, transportation, and receiving costs grow with the

variety of products or pickup points

• Lot sizes and ordering policy that minimize total cost

Di: Annual demand for product i

S: Order cost incurred each time an order is placed,
independent of the variety of products in the order
si: Additional order cost incurred if product i is included in the
order
 Lot Sizing with Multiple
Products or Customers

• Three approaches
Each product manager orders his or her model independently
The product managers jointly order every product in each lot
Product managers order jointly but not every order contains
every product; that is, each lot contains a selected subset of the
products
 Multiple Products Ordered and
Delivered Independently

Demand
DL = 12,000/yr, DM = 1,200/yr, DH = 120/yr

Common order cost

S = $4,000

Product-specific order cost

sL = $1,000, sM = $1,000, sH = $1,000

Holding cost
h = 0.2

Unit cost
CL = $500, CM = $500, CH = $500
Multiple Products Ordered and Delivered
Independently

Litepro Medpro Heavypro

Demand per year 12,000 1,200 120
Fixed cost/order $5,000 $5,000 $5,000
Optimal order size 1,095 346 110
Cycle inventory 548 173 55
Annual holding cost $54,772 $17,321 $5,477
Order frequency 11.0/year 3.5/year 1.1/year
Annual ordering cost $54,772 $17,321 $5,477
Average flow time 2.4 weeks 7.5 weeks 23.7 weeks
Annual cost $109,544 $34,642 $10,954

• Total annual cost = $155,140

Lots Ordered and Delivered Jointly

S* = S + sL + sM + sH Annual order cost = S * n

DL hC L DM hCM DH hC H
Annual holding cost = + +
2n 2n 2n

DL hC L DM hCM DH hC H
Total annual cost = + + +S*n
2n 2n 2n

å
k
DL hC L + DM hCM + DH hC H Di hCi
n* = n* = i=1

2S * 2S *
Products Ordered and Delivered Jointly

S* = S + sA + sB + sC = $7,000 per order

12,000 ´100 +1,200 ´100 +120 ´100

n* = = 9.75
2 ´ 7,000

Annual order cost = 9.75 x 7,000 = $68,250

Annual ordering
and holding cost = $61,512 + $6,151 + $615 + $68,250
= $136,528
Products Ordered and Delivered Jointly

Litepro Medpro Heavypro

Demand per year (D) 12,000 1,200 120
Order frequency (n∗) 9.75/year 9.75/year 9.75/year
Optimal order size (D/n∗) 1,230 123 12.3
Cycle inventory 615 61.5 6.15
Annual holding cost $61,512 $6,151 $615
Average flow time 2.67 weeks 2.67 weeks 2.67 weeks
Aggregation with Capacity Constraint

• W.W. Grainger example

Demand per product, Di = 10,000
Holding cost, h = 0.2
Unit cost per product, Ci = $50
Common order cost, S = $500
Supplier-specific order cost, si = $100
Aggregation with Capacity Constraint

S* = S + s1 + s2 + s3 + s4 = $900 per order

å
4
D1hC1 4 ´10,000 ´ 0.2 ´ 50
n* = i=1
= = 14.91
2S * 2 ´ 900

900
Annual order cost = 14.91´ = $3,354
4

Annual holding hCi Q 671

= = 0.2 ´ 50 ´ = $3,355
cost per supplier 2 2
 Aggregation with Capacity Constraint

Total required capacity per truck = 4 x 671 = 2,684 units

Truck capacity = 2,500 units
Order quantity from each supplier = 2,500/4 = 625
Order frequency increased to 10,000/625 = 16
Annual order cost per supplier increases to $3,600
Annual holding cost per supplier decreases to $3,125.
Lots Ordered and Delivered Jointly for a
Selected Subset

Step 1: Identify the most frequently ordered product assuming

each product is ordered independently

hCi Di
ni =
2(S + si )

Step 2: For all products i ≠ i*, evaluate the ordering frequency

hCi Di
ni =
2si
Lots Ordered and Delivered Jointly for a
Selected Subset

Step 3: For all i ≠ i*, evaluate the frequency of product i relative

to the most frequently ordered product i* to be mi

é ù
mi = ên / ni ú

Step 4: Recalculate the ordering frequency of the most

frequently ordered product i* to be n

å
l
hCi mi D
n= i=1

(
2 S + å si / mi
l

i=1 )
Lots Ordered and Delivered Jointly for a
Selected Subset

Step 5: Evaluate an order frequency of ni = n/mi and the total

cost of such an ordering policy
l l æD ö
TC = nS + å ni si + åç i ÷ hC1
i=1 i-1 è 2ni ø

Tailored aggregation – Higher-demand products ordered more

frequently and lower-demand products ordered less frequently
Ordered and Delivered Jointly – Frequency
Varies by Order

• Applying Step 1

hC L DL
nL = = 11.0
2(S + sL ) Thus,
n = 11.0
hC M DM
nM = = 3.5
2(S + sM )

hC H DH
nL = = 1.1
2(S + sH )
Ordered and Delivered Jointly – Frequency
Varies by Order

• Applying Step 2

hCM DM hC H DH
nM = = 7.7 and nH = = 2.4
2sM 2sH

• Applying Step 3

é ù é ù é ù é ù
n 11.0 n 11.0
mM = ê ú = ê ú = 2 and mH = ê ú = ê ú=5
ê n ú ê 7.7 ú ê n ú ê 2.4 ú
ê Mú ê Hú
Ordered and Delivered Jointly – Frequency
Varies by Order

Litepro Medpro Heavypro

Demand per year (D) 12,000 1,200 120
Order frequency (n∗) 11.47/year 5.74/year 2.29/year
Optimal order size (D/n∗) 1,046 209 52
Cycle inventory 523 104.5 26
Annual holding cost $52,307 $10,461 $2,615
Average flow time 2.27 weeks 4.53 weeks 11.35 weeks
 Ordered and Delivered Jointly —
Frequency Varies by Order

• Applying Step 4
n = 11.47
• Applying Step 5

nL = 11.47 / yr nM = 11.47 / 2 = 5.74 / yr

nH = 11.47 / 5 = 2.29 / yr

Annual order cost Total annual cost

nS + nL sL + nM sM + nH sH = $65,383.5 $130,767
 Economies of Scale to
Exploit Quantity Discounts

• Lot size-based discount – discounts based on quantity ordered in a

single lot

• Volume based discount – discount is based on total quantity

purchased over a given period

• Two common schemes

All-unit quantity discounts
Marginal unit quantity discount or multi-block tariffs
 Quantity Discounts

• Two basic questions

What is the optimal purchasing decision for a buyer seeking to
maximize profits? How does this decision affect the supply chain
in terms of lot sizes, cycle inventories, and flow times?
Under what conditions should a supplier offer quantity
discounts? What are appropriate pricing schedules that a
supplier seeking to maximize profits should offer?
 All-Unit Quantity Discounts

• Pricing schedule has specified quantity break points q0, q1, …, qr,
where q0 = 0

• If an order is placed that is at least as large as qi but smaller

than qi+1, then each unit has an average unit cost of Ci

• Unit cost generally decreases as the quantity increases, i.e., C0 >

C1 > … > C r

• Objective is to decide on a lot size that will minimize the sum of

material, order, and holding costs
All-Unit Quantity Discounts
 All-Unit Quantity Discounts

Step 1: Evaluate the optimal lot size for each price Ci,0 ≤ i ≤ r as
follows

2DS
Qi =
hCi
 All-Unit Quantity Discounts

Step 2: We next select the order quantity Q*i for each price Ci
1. qi £ Qi < qi+1
2. Qi < qi
3. Qi ³ qi+1
• Case 3 can be ignored as it is considered for Qi+1
• For Case 1 if qi £ Qi < qi+1 , then set Q*i = Qi
• If Qi < qi , then a discount is not possible
• Set Q*i = qi to qualify for the discounted price of Ci
 All-Unit Quantity Discounts

Step 3: Calculate the total annual cost of ordering Q*i units

æDö æ Q* ö
Total annual cost, TCi = çç * ÷÷ S + çç i ÷÷ hCi + DCi
è Qi ø è 2ø
 All-Unit Quantity Discounts

Step 4: Select Q*i with the lowest total cost TCi

• Cutoff price

1æ DS h ö
C* = ç DCr + + qrCr – 2hDSCr ÷
Dè qr 2 ø
All-Unit Quantity Discount Example

Order Quantity Unit Price

0–4,999 $3.00
5,000–9,999 $2.96
10,000 or more $2.92

q0 = 0, q1 = 5,000, q2 = 10,000

C0 = $3.00, C1 = $2.96, C2 = $2.92

D = 120,000/year, S = $100/lot, h = 0.2

 All-Unit Quantity Discount Example

Step 1

2DS 2DS 2DS

Q0 = = 6,324; Q1 = = 6,367; Q2 = = 6,410
hC0 hC1 hC2

Step 2

Ignore i = 0 because Q0 = 6,324 > q1 = 5,000

For i = 1, 2

Q1* = Q1 = 6,367; Q2* = q2 = 10,000

 All-Unit Quantity Discount Example

Step 3
æDö æ Q* ö
TC1 = çç * ÷÷ S + çç 1 ÷÷ hC1 + DC1 = $358,969; TC2 = $354,520
è Q1 ø è 2 ø

Lowest total cost is for i = 2

Order Q*2 bottles per lot at $2.92 per bottle

 Marginal Unit Quantity Discounts

• Multi-block tariffs – The marginal cost of a unit that

decreases at a breakpoint

For each value of i, 0 ≤ i ≤ r, let Vi be the cost of ordering qi units

Vi = C0 (q1 – q0 ) + C1(q2 – q1) + ...+ Ci–1(qi – qi–1)

Marginal Unit Quantity Discounts
 Marginal Unit Quantity Discounts

Material cost of each order Q is Vi + (Q – qi)Ci

æ Dö
Annual order cost = ç ÷ S
èQø
Annual holding cost = éëVi + (Q – qi )C i ùû h / 2
Dé
Annual materials cost = ëVi + (Q – qi )Ci ùû
Q
æ Dö
Total annual cost = ç ÷ S + éëVi + (Q – qi )C i ùû h / 2
èQø
D
+ éëVi + (Q – qi )Ci ùû
Q
 Marginal Unit Quantity Discounts

Step 1: Evaluate the optimal lot size for each price Ci

2D(S +Vi – qiCi )

Optimal lot size for Ci is Qi =
hCi
 Marginal Unit Quantity Discounts

Step 2: Select the order quantity Qi* for each price Ci

1. If qi £ Qi £ qi+1 then set Qi* = Qi

2. If Qi < qi then set Qi* = qi

3. If Qi > qi+1 then set Qi* = qi+1
 Marginal Unit Quantity Discounts

Step 3: Calculate the total annual cost of ordering Qi*

æDö Dé
ç ÷ é * ù
TCi = ç * ÷ S + ëVi + (Qi – qi )C i û h / 2 + * ëVi + (Qi* – qi )Ci ùû
è Qi ø Qi

Step 4: Select the order size Qi* with the lowest total cost
TCi
Marginal Unit Quantity Discount Example

• Original data now a marginal discount

Order Quantity Unit Price

0–4,999 $3.00
5,000–9,999 $2.96
10,000 or more $2.92

q0 = 0, q1 = 5,000, q2 = 10,000

C0 = $3.00, C1 = $2.96, C2 = $2.92

D = 120,000/year, S = $100/lot, h = 0.2

Marginal Unit Quantity Discount Example

V0 = 0; V1 = 3(5,000 – 0) = $15,000
V2 = 3(5,000 – 0) + 2.96(10,000 – 5,000) = $29,800
Step 1
2D(S +V0 – q0C0 )
Q0 = = 6,324
hC0

2D(S +V1 – q1C1)

Q1 = = 11,028
hC1

2D(S +V2 – q2C2 )

Q2 = = 16,961
hC2
Marginal Unit Quantity Discount Example

Step 2
Q0* = q1 = 5,000 because Q0 = 6,324 > 5,000
Q1* = q2 = 10,000; Q2 = Q2 = 16,961

Step 3
æDö D
TC0 = çç * ÷÷ S + éëV0 + (Q0* – q0 )C 0 ùû h / 2 + * éëV0 + (Q0* – q0 )C0 ùû = $363,900
è Q0 ø Q0

æDö D
TC1 = çç * ÷÷ S + éëV1 + (Q1* – q1)C 1ùû h / 2 + * éëV1 + (Q1* – q1)C1ùû = $361,780
è Q1 ø Q1

æDö D
TC2 = çç * ÷÷ S + éëV2 + (Q2* – q2 )C 2 ùû h / 2 + * éëV2 + (Q2* – q2 )C2 ùû = $360,365
è Q2 ø Q2
 Why Quantity Discounts?

• Quantity discounts can increase the supply chain surplus for the
following two main reasons
Improved coordination to increase total supply chain profits
Extraction of surplus through price discrimination
Quantity Discounts for Commodity
Products

D = 120,000 bottles/year, SR = $100, hR = 0.2, CR = $3

SM = $250, hM = 0.2, CM = $2

2DS R 2 ´120,000 ´100

QR = = = 6,324
hRC R 0.2 ´ 3
æDö æQ ö
Annual cost for DO = ç ÷ S R + ç R ÷ hRC R = $3,795
è QR ø è 2 ø
æDö æQ ö
Annual cost for manufacturer = ç ÷ S M + ç R ÷ hM CM = $6,009
è QR ø è 2 ø

Annual supply chain cost

= $6,009 + $3,795 = $9,804
(manufacturer + DO)
 Locally Optimal Lot Sizes

Annual cost for DO æ D ö æQ ö æ Dö æQ ö

= ç ÷ S R + ç ÷ hRC R + ç ÷ S M + ç ÷ hM CM
and manufacturer èQø è2ø èQø è2ø

2D(S R + S M )
Q* = = 9,165
hRC R + hM CM

æ D ö æQ *ö
Annual cost for DO = ç ÷ SR + ç ÷ hRC R = $4,059
èQ *ø è 2 ø
æ D ö æQ *ö
Annual cost for manufacturer = ç ÷ SM + ç ÷ hM CM = $5,106
èQ *ø è 2 ø
Annual supply chain cost
= $5,106 + $4,059 = $9,165
(manufacturer + DO)
 Designing a Suitable Lot Size-Based
Quantity Discount

• Design a suitable quantity discount that gets DO to order in lots of

9,165 units when its aims to minimize only its own total costs

• Manufacturer needs to offer an incentive of at least $264 per year

to DO in terms of decreased material cost if DO orders in lots of
9,165 units

• Appropriate quantity discount is $3 if DO orders in lots smaller

than 9,165 units and $2.9978 for orders of 9,165 or more
 Quantity Discounts When
Firm Has Market Power

Demand curve = 360,000 – 60,000p

Production cost = CM = $2 per bottle

Prof R = ( p – C R )(360,000 – 60,000 p)

Prof M = (C R – CM )(360,000 – 60,000 p)
CR
p to maximize ProfR p = 3+
2
æ æ C R öö
Prof M = (C R – CM ) çç 360,000 – 60,000 ç 3 + ÷÷÷
è è 2 øø
= (CR – 2)(180,000 – 30,000CR )
 Quantity Discounts When
Firm Has Market Power

CR = $4 per bottle, p = $5 per bottle

Total market demand = 360,000 – 60,000p = 60,000
ProfR = (5 – 4)(360,000 – 60,000 × 5) = $60,000
ProfM = (4 – 2)(360,000 – 60,000 × 5) = $120,000

ProfSC = (p – CM)(360,000 – 60,000p)

Coordinated retail price CM 2

p = 3+ = 3 + = $4
2 2
ProfSC = ($4 – $2) x 120,000 = $240,000
 Two-Part Tariff

• Manufacturer charges its entire profit as an up-front franchise fee

ff

• Sells to the retailer at cost

• Retail pricing decision is based on maximizing its profits

• Effectively maximizes the coordinated supply chain profit

 Volume-Based Quantity Discounts

• Design a volume-based discount scheme that gets the retailer

to purchase and sell the quantity sold when the two stages
coordinate their actions
 Lessons from Discounting Schemes

• Quantity discounts play a role in supply chain coordination and

improved supply chain profits

• Discount schemes that are optimal are volume based and not lot
size based unless the manufacturer has large fixed costs
associated with each lot

• Even in the presence of large fixed costs for the manufacturer, a

two-part tariff or volume-based discount, with the manufacturer
passing on some of the fixed cost to the retailer, optimally
coordinates the supply chain and maximizes profits
 Lessons from Discounting Schemes

• Lot size–based discounts tend to raise the cycle inventory in the

supply chain
• Volume-based discounts are compatible with small lots that
reduce cycle inventory
• Retailers will tend to increase the size of the lot toward the end
of the evaluation period, the hockey stick phenomenon
• With multiple retailers with different demand curves optimal
discount continues to be volume based with the average price
charged to the retailers decreasing as the rate of purchase
increases
 Price Discrimination to Maximize
Supplier Profits

• Firm charges differential prices to maximize profits

• Setting a fixed price for all units does not maximize profits for the
manufacturer
• Manufacturer can obtain maximum profits by pricing each unit
differently based on customers’ marginal evaluation at each
quantity
• Quantity discounts are one mechanism for price discrimination
because customers pay different prices based on the quantity
purchased
 Short-Term Discounting:
Trade Promotions

• Trade promotions are price discounts for a limited period of time

• Key goals
Induce retailers to use price discounts, displays, or advertising
to spur sales
Shift inventory from the manufacturer to the retailer and the
customer
Defend a brand against competition
 Short-Term Discounting:
Trade Promotions

• Impact on the behavior of the retailer and supply chain

performance

• Retailer has two primary options

Pass through some or all of the promotion to customers to
spur sales
Pass through very little of the promotion to customers but
purchase in greater quantity during the promotion period to
exploit the temporary reduction in price (forward buy)
Forward Buying Inventory Profile
 Forward Buy

• Costs to be considered – material cost, holding cost, and order

cost

• Three assumptions
The discount is offered once, with no future discounts
The retailer takes no action to influence customer demand
Analyze a period over which the demand is an integer multiple
of Q*
 Forward Buy

• Optimal order quantity

dD CQ *
Q =
d
+
(C – d)h C – d

• Retailers are often aware of the timing of the next promotion

Forward buy = Q d – Q *
Impact of Trade Promotions on Lot Sizes

Q* = 6,324 bottles, C = $3 per bottle

d = $0.15, D = 120,000, h = 0.2

Cycle inventory at DO = Q*/2 = 6,324/2 = 3,162 bottles

Average flow time = Q*/2D = 6,324/(2D) = 0.3162 months

dD CQ *
Q =
d
+
(C – d)h C – d
0.15 ´120,000 3 ´ 6,324
= + = 38,236
(3.00 – 0.15) ´ 0.20 3.00 – 0.15
Impact of Trade Promotions on Lot Sizes

• With trade promotions

Cycle inventory at DO = Qd/2 = 38,236/2 = 19,118 bottles

Average flow time = Qd/2D = 38,236/(20,000)

= 1.9118 months

Forward buy = Qd – Q* = 38,236 – 6,324 = 31,912 bottles

 How Much of a Discount Should the
Retailer Pass Through?

• Profits for the retailer

ProfR = (300,000 – 60,000p)p – (300,000 – 60,000p)CR
• Optimal price
p = (300,000 + 60,000CR)/120,000

• Demand with no promotion

DR = 30,000 – 60,000p = 60,000

• Optimal price with discount

p = (300,000 + 60,000 x 2.85)/120,000 = $3.925

• Demand with promotion

DR = 300,000 - 60,000p = 64,500
 Trade Promotions

• Trade promotions generally increase cycle inventory in a supply

chain and hurt performance

• Counter measures
EDLP (every day low pricing)
Discount applies to items sold to customers (sell-through) not
the quantity purchased by the retailer (sell-in)
Scan based promotions
 Managing Multiechelon
Cycle Inventory

• Multi-echelon supply chains have multiple stages with possibly

many players at each stage

• Lack of coordination in lot sizing decisions across the supply chain

results in high costs and more cycle inventory than required

• The goal is to decrease total costs by coordinating orders across

the supply chain
Managing Multiechelon
Cycle Inventory
 Integer Replenishment Policy

• Divide all parties within a stage into groups such that all parties
within a group order from the same supplier and have the same
reorder interval

• Set reorder intervals across stages such that the receipt of a

replenishment order at any stage is synchronized with the
shipment of a replenishment order to at least one of its
customers

• For customers with a longer reorder interval than the supplier,

make the customer’s reorder interval an integer multiple of the
supplier’s interval and synchronize replenishment at the two
stages to facilitate cross-docking
 Integer Replenishment Policy

• For customers with a shorter reorder interval than the supplier,

make the supplier’s reorder interval an integer multiple of the
customer’s interval and synchronize replenishment at the two
stages to facilitate cross-docking

• The relative frequency of reordering depends on the setup cost,

holding cost, and demand at different parties

• These polices make the most sense for supply chains in which
cycle inventories are large and demand is relatively predictable
Integer Replenishment Policy
Integer Replenishment Policy

Figure 11-8
 Summary

• Balance the appropriate costs to choose the optimal lot size and
cycle inventory in a supply chain

• Understand the impact of quantity discounts on lot size and cycle

inventory

• Devise appropriate discounting schemes for a supply chain

• Understand the impact of trade promotions on lot size and cycle

inventory

Contd…
 Summary

• Identify managerial levers that reduce lot size and cycle

inventory in a supply chain without increasing cost
Reduce fixed ordering and transportation costs incurred per
order
Implement volume-based discounting schemes rather than
individual lot size–based discounting schemes
Eliminate or reduce trade promotions and encourage EDLP –
base trade promotions on sell-through rather than sell-in to the
retailer