INVENTORY CONTROL PROBLEM OF A SINGLE WAREHOUSE AND A MULTI-RETAILER DISTRBUTION SYSTEM (A CASE OF CHOCHO INDUSTRY)
ABSTRACT
In many distribution systems important cost reductions and/or service improvements may be achieved by adopting efficient inventory replenishment strategies for all items and facilities concerned. Such strategies often need to exploit economies of scale that arise e.g. when shipping full (or close to full) rail loads or truck loads of goods. The latter can often only be achieved
by combining deliveries to distinct locations into efficient routes. These efficiency improvements and service enhancements clearly require an integrated approach towards various logistical planning functions; in particular the areas of inventory control and transportation planning need to be closely coordinated; for example, shipping in smaller quantities and with higher frequency generally leads to reductions in inventory investments but requires additional transportation costs. In this thesis we considered distribution systems with a single depot and many geographically dispersed retailers each of which faces a specific demand process for a given item. All stock enters the system through the depot from where it is distributed to (some of) the retailers by a fleet of trucks, combining deliveries into efficient routes. Our objective is to determine long-term integrated replenishment strategies (i.e., inventory rules and
routing patterns) enabling all retailers to meet their demands while minimizing long-run average system-wide transportation and inventory costs.
We applied Route First Cluster Second approach to determine feasible replenishment strategies (i.e., inventory rules and routing patterns) minimizing (infinite horizon) long-run average transportation and inventory costs. A numerical study exhibits the performance of these heuristics and reduced the distribution cost of the company drastically
TABLE OF CONTENT
CERTIFICATION… ii
DEDICATION iii
ACKNOWLEDGEMENT iv
ABSTRACT v
TABLE OF CONTENT… vi
LIST OFTABLES… ix
LIST OF FIGURES… x
LIST OF ABBREVIATION xi
CHAPTER 1 1
Introduction 1
Background of study 2
Problem statement 11
Objectives 12
Methodology 12
Justification 13
Significance of the study 13
Scope of Study 13
Limitation of the study 14
Organization of study 14
2.0 Summary 14
CHAPTER 2 16
LITERATURE REVIEW 16
SUMMARY… 53
CHAPTER 3 54
METHODOLOGY 54
Introduction 54
The basic EOQ model 55
Cluster First-Route Secound Algorithm 58
The Sweep Algorithm 59
The Two-Phase Method 59
The Power of Two Policies 61
The Nearest Neighbor Algorithm 62
CHAPTER 4 64
DATA COLLECTION AND ANALYSIS 64
Introduction 64
Data Collection and Analysis 64
Results 73
Conclusions 73
CHAPTER 5 74
CONCLUSIONS AND RECOMMENNDATIONS 74
Introduction 74
Conclusions 76
Recommendations 76
REFERENCES 77
CHAPTER 1 INTRODUCTION
OVERVIEW
A distribution system consists of a depot and many retailers. Dispersed retailers have demands that must be supplied by a depot. Retailers’ demands result from customers’ demands whereas demands occurring at a depot depend on retailers’ demands.
The depot has to respond to retailers’ demands. Thus, this distribution system involves the replenishment of inventories for geographically dispersed retailers or customers. In a distribution system with one warehouse and many dispersed retailers, the vehicles based at the warehouse are required to travel to retailers. The objective is to distribute commodities to satisfy customers’ demands. Each retailer possesses a specific demand that must be satisfied. The warehouse has to decide how and when to replenish the commodities. For example, for a distribution centre with many retailers at different location, the distribution centre has to assign vehicles to visit and supply its retailers according to recurring demands. A vehicle, which is loaded with many items, travels to a given area and replenishes the inventory at each retailer until all retailers are visited or the vehicle is empty. The vehicle then returns to the warehouse and reloads.
Since retailers have different demands and vehicles have limited capacities, a shortage or excess inventory may occur. The different demand rates will give varying replenishment periods and quantities. Retailers with higher consumption rates need a higher frequency of inventory replenishment or lager order sizes. Therefore, when a vehicle visits a group
of retailers, some retailers’ demands may not be met because of inappropriate replenishment policies including periods and quantities. Some retailer’s inventories may not be satisfied by the existing vehicle capacity and a shortage of product will occur. Some retailers may not receive products at the right time. If the vehicle arrives before the replenishment periods, the retailers have to hold more products and incur holding cost.
The one warehouse and multi-retailer distribution system involves transportation cost as well. Since vehicle capacity is limited, all retailers’ demands may not be fulfilled with one trip of a vehicle. The travelling distance of vehicles and the number of trips obviously affect transportation cost. The transportation cost will be minimized if the vehicle capacity is utilized and a vehicle is assigned to visit a group of retailers that are close together. However, for a given replenishment period, a retailer may be located far away from other retailers. Naturally, the retailer that is located far away from the warehouse and has low demand may not be replenished very often. Therefore, the depot has to decide the appropriate routes to minimize the travelling distance so that vehicle capacity is utilized while inventory requirements are satisfied.
BACKGROUND OF STUDY
Inventories are essential for keeping the production wheels moving, keep the market going and the distribution system intact. They serve as lubrication and spring for the production and distribution systems of organizations. Inventories make possible the smooth and efficient operation of manufacturing organizations by decoupling individual segments of the total operation. Purchased parts inventory permits activities of the purchasing and supply department personnel to be planned, controlled and concluded
somewhat independently of shop-product operations. These inventories allow additional flexibility for suppliers in planning, producing and delivering an order for a given product’s part, Loner (2003).
Inventory is essential to organization for production activities, maintenance of plant and machinery as well as other operational requirements. This results in tying up of money or capital which could have been used more productively. The management of an organization becomes very concerned if inventory stocks are high. Inventory is part of the company assets and is always reflected in the company’s balance sheet. This therefore calls for its close scrutiny by management (Salleem, 2004).
Management is very critical about any shortage of inventory items required for production. Any increase in the redundancy of machinery or operations due to shortages of inventory may lead to production loss and its associated costs. These two aspects call for continuous inventory control. Inventory control and management not only looks at the physical balance of materials but also at aspects of minimizing the inventory cost.
The classic dilemma in inventory management is maintained in high service levels to meet the needs of customers while avoiding high stocks regardless of the type of items or even the department for which such stock is purchased.
Dobler and Burt (2000) argues that well and efficiently controlled inventories can contribute to the effective operation of the firm and hence the firm’s overall profit. Proper management of inventory plays a big role in enabling other operations such as production, purchases, sales, marketing and financial management to be carried out
smoothly. Basic challenge however is to determine the inventory level that works most effectively with the operating system or system existing within the organization.
Inventory management is pivotal in effective and efficient organization. It is also vital in the control of materials and goods that have to be held (or stored) for later use in the case of production or later exchange activities in the case of services. The principal goal of inventory management involves having to balance the conflicting economics of not wanting to hold too much stock. Thereby having to tie up capital so as to guide against the incurring of costs such as storage, spoilage, pilferage and obsolescence and, the desire to make items or goods available when and where required (quality and quantity wise) so as to avert the cost of not meeting such requirement.
Inventory problems of too great or too small quantities on hand can cause business failures. If a manufacturer experiences stock-out of a critical inventory item, production halts could result. Moreover, a shopper expects the retailer to carry the item wanted. If an item is not stocked when the customer thinks it should be, the retailer loses a customer not only on that item but also on many other items in the future. The conclusion one might draw is that effective inventory management can make a significant contribution to a company’s profit as well as increase its return on total assets. It is thus the management of this economics of stockholding, that is appropriately being refers to as inventory management. The reason for greater attention to inventory management is that this figure, for many firms, is the largest item appearing on the asset side of the balance sheet.
Essentially, inventory management, within the context of the foregoing features involves planning and control. The planning aspect involves looking ahead in terms of the determination in advance:
(i) What quantity of items to order; and (ii) How often (periodicity) do we order for them to maintain the overall source-store sink coordination in an economically efficient way? The control aspect, which is often described as stock control involves following the procedure, set up at the planning stage to achieve the above objective. This may include monitoring stock levels periodically or continuously and deciding what to do on the basis of information that is gathered and adequately processed.
Effort must be made by the management of any organization to strike an optimum investment in inventory since it costs much money to tie down capital in excess inventory. In recent time, attention was focused on the development of suitable mathematical tools and approaches designed to aid the decision-maker in setting optimum inventory levels. Economic order quantity model (EOQ) has thus been developed to take care of the weaknesses emanating from the traditional methods of inventory control and valuation, which to some extent has proved useful in optimizing resources and thus, minimizing associated cost.
Financial analysts have sounded enough warning on the danger expose to the long run profitability as well as continuity of business concern when its inventories are left unmanaged.
First, a company, which neglects it management of inventory, runs the risk of production bottlenecks and subsequently unable to maintain the minimum investment it requires to maximized profit. Second, inventories that are inefficiently managed may apart from
affecting sales create an irreparable loss in market for companies operating in highly competitive industry. Invariably, a company must neither keep excess inventories to avoid an unnecessary tying down of funds as well as loss in fund due to pilferage, spoilage and obsolescence nor maintain too low inventories so as to meet production and sales demand as at when needed.
The Economic Order Quantity is the number of units that a company should add to inventory with each order to minimize the total costs of inventory such as holding costs, order costs, and shortage costs. The EOQ is used as part of a continuous review inventory system, in which the level of inventory is monitored at all times, and a fixed quantity is ordered each time the inventory level reaches a specific reorder point. The EOQ provides a model for calculating the appropriate reorder point and the optimal reorder quantity to ensure the instantaneous replenishment of inventory with no shortages. It can be a valuable tool for small business owners who need to make decisions about how much inventory to keep on hand, how many items to order each time, and how often to reorder to incur the lowest possible costs (Muhammad and Omar, 2011).
The EOQ model assumes that demand is constant, and that inventory is depleted at a fixed rate until it reaches zero. At that point, a specific number of items arrive to return the inventory to its beginning level. Since the model assumes instantaneous replenishment, there are no inventory shortages or associated costs. Therefore, the cost of inventory under the EOQ model involves a trade-off between inventory holding costs (the cost of storage, as well as the cost of tying up capital in inventory rather than investing it or using it for other purposes) and order costs (any fees associated with placing orders, such as delivery charges). Ordering a large amount at one time will increase a small
business's holding costs, while making more frequent orders of fewer items will reduce holding costs but increase order costs. The EOQ model finds the quantity that minimizes the sum of these costs (Bhavin et al., 2007).
The purpose of the EOQ model is simply, to find that particular quantity to order which minimizes the total variable costs of inventory. Total variable costs are usually computed on an annual basis and include two components, the costs of ordering and holding inventory. Annual ordering cost is the number of orders placed times the marginal or incremental cost incurred per order. This incremental cost includes several components: the costs of preparing the purchase order, paying the vendor's invoice, and inspecting and handling the material when it arrives. It is difficult to estimate these components precisely but a ball-park figure is good enough. The EOQ is not especially sensitive to errors in inputs (www.usersolutions.com).
The holding costs used in the EOQ should also be marginal in nature. Holding costs include insurance, taxes, and storage charges, such as depreciation or the cost of leasing a warehouse. One should also include the interest cost of the money tied up in inventory. Many companies also add a factor to the holding cost for the risk that inventory will spoil or become obsolete before it can be used (www.usersolutions.com).
Inventories are essential for keeping the production wheels moving, keep the market going and the distribution system intact. They serve as lubrication and spring for the production and distribution systems of organizations. Inventories make possible the smooth and efficient operation of manufacturing organizations by decoupling individual segments of the total operation. Purchased parts inventory permits activities of the purchasing and supply department personnel to be planned, controlled and concluded
somewhat independently of shop-product operations. These inventories allow additional flexibility for suppliers in planning, producing and delivering an order for a given product’s part, Lonergan (2001).
Inventory is essential to organization for production activities, maintenance of plant and machinery as well as other operational requirements. This results in tying up of money or capital which could have been used more productively. The management of an organization becomes very concerned if inventory stocks are high. Inventory is part of the company assets and is always reflected in the company’s balance sheet. This therefore calls for its close scrutiny by management (Salleem, 2004).
Management is very critical about any shortage of inventory items required for production. Any increase in the redundancy of machinery or operations due to shortages of inventory may lead to production loss and its associated costs. These two aspects call for continuous inventory control. Inventory control and management not only looks at the physical balance of materials but also at aspects of minimizing the inventory cost. The classic dilemma in inventory management is maintained in high service levels to meet the needs of customers while avoiding high stocks regardless of the type of items or even the department for which such stock is purchased.
From a financial accounting viewpoint, the cost assigned to inventory directly affects net income. If ending inventory is overstated, then net income is overstated and conversely, if ending inventory is understated then net income is understated.
Also, the use of direct costing rather than absorption costing can affect net income. From a management accounting viewpoint, there are variety of inventory decisions that affect net income. Decisions regarding inventory can be placed in two general categories:
(1) those decisions that affect the quantity of inventory and (2) those decisions that affect the per unit cost of inventory.
Decisions that affect the quantity of inventory
(i) Order size
(ii) Number of orders
(iii) Safety stock
(iv) Lead time
(v) Planned production
Decisions that affect the cost per unit of inventory
(i) Suppliers of raw material (list price and discounts)
(ii) Order size (quantity discounts)
(iii) Freight
In addition, decisions pertaining to labour and overhead also indirectly affect the per unit cost of inventory. In a manufacturing business, the costs of labour and overhead do not become operating expenses until the manufacturing costs appear as part of cost of goods sold. Labour and overhead costs are deferred in inventory until the inventory has been sold.
The main management accounting tool that may be used to make inventory purchase decisions is the EOQ model. This tool recognizes that there are two major decisions regarding the materials inventory: (i) orders size and (ii) number of orders.
There are consequently two major questions:
(i) How many units should be purchased each time a purchase is made (order size)?
(ii) How many purchases should be made (number of orders)?
To understand an EOQ model, it is essential that the concept of average inventory be understood. Inventory is never static and is constantly rising and falling over time, even in the very short term. Inventory, for example, rises when raw materials are purchased and falls when raw material is used. Because inventory in a business is constantly changing, it is necessary to think in terms of average inventory levels.
The high points and low points of inventory are easy to explain and illustrate, if a purchasing policy is consistently applied and the rate of usage of raw material is uniform. Inventory is at its highest and lowest levels when a new shipment of material arrives. Theoretically, in absence of a need for safety stock, a new shipment should arrive at the moment inventory reaches zero. Immediately, upon arrival of a new shipment, inventory is then at its highest level again.
PROBLEM STATEMENT
For many organizations, there is no doubt that inventory management enhances their operations. Organizations with high levels of finished goods inventory can offer a wide range of products and make quick delivery from their backyards to the customers.
The one warehouse and multi-retailer distribution system involves transportation cost as well. Since vehicle capacity is limited, all retailers’ demands may not be fulfilled with one trip of a vehicle. The travelling distance of vehicles and the number of trips obviously affect transportation cost. The transportation cost will be minimized if the
vehicle capacity is utilized and a vehicle is assigned to visit a group of retailers that are close together. However, for a given replenishment period, a retailer may be located far away from other retailers. Naturally, the retailer that is located far away from the warehouse and has low demand may not be replenished very often. Therefore, the depot has to decide the appropriate routes to minimize the travelling distance so that vehicle capacity is utilized while inventory requirements are satisfied.
Our study focuses on one warehouse multi-retailer distribution problem for finding replenishment policies that specify delivery quantities, delivery intervals and vehicle routes that minimize inventory and transportation costs of Chocho Industry.
OBJECTIVES
The objectives of this study are as follows:
(i) To find replenishment policies that specify delivery quantities, delivery intervals and vehicle routes that minimize inventory and transportation costs.
(ii) To determine whether or not inventory management in the Company can be evaluated and understood using the various existing tools of optimization in inventory management and,
(iii) To determine the optimality in the company inventory policies.
METHODOLOGY
Optimization procedures of the one warehouse multi-retailer inventory distribution problem is an effective tool to model, analyze and optimize any inventory systems. It is useful in forecasting the behaviour of systems with both continuous and discrete variables like a typical inventory system. Discrete and continuous systems need to be modelled or designed into complex systems. This complex system or model must be linked with a specific simulation optimization technique that best calculate the output.
In our methodology, we shall apply Cluster First Route Second methods in solving our problem.
JUSTIFICATION
The objective of the one warehouse multi-retailer distribution problem is to find replenishment policies that specify delivery quantities, delivery intervals and vehicle routes that minimize inventory and transportation costs.
Since each retailer has a different demand, the warehouse has to supply each retailer with different order quantities and replenishment periods. In addition, the warehouse has to decide which retailer can be served by the same route. Thus, to solve this distribution system, we must include both the inventory problem and the vehicle routing problem, hence the reason for the study.
SIGNIFICANCE OF THE STUDY
The findings of the study will provide well–researched information, which can be useful to researchers for academic purposes in the area of inventory management. To the stores
and Procurement department staff, the study hopes to provide them with useful information like the recommended techniques of inventory control so as to meet their customer’s and organization’s needs. To the firm’s management, the recommendations of the study may enable them to design inventory management policies to improve the smooth running of the firm, thereby satisfying customers and generally minimizing costs.
SCOPE OF THE STUDY
The scope of the study will be limited to the impact of inventory management on the performance of an organization. The study will be carried out at Chocho Industry.
LIMITATIONS OF THE STUDY
The scope of the study will be limited to the impact of inventory management on the performance of an organization. The study will be carried out at Chocho Industries Limited in Suhum, and would involve the staff of the firm’s Stores, Procurement Unit, Transport Departments and Management.
ORGANIZATION OF THE THESIS
In chapter one, we presented a background study of inventory control and economic order quantity models.
In chapter two, related work in the integrated inventory and economic order quantity model would be discussed.
In chapter three, the cluster first route second optimization procedures and methods that would be applied in solving our problem will be introduced and explained.
Chapter four will provide a computational study of the algorithm applied to our integrated inventory control and economic order quantity instances.
Chapter five will conclude this thesis with additional comments and recommendations
SUMMARY
The inventory system has diverse decision variables that can be considered as continuous like regular orders, demand on the stock, regular supply et cetera. On the other hand, there are discrete variables like special orders that come in at a particular time, theft or accidents that occur without any warning. Based on the kind of information that management or decision makers need to enable them plan properly for their inventory, these discrete and continuous variables always play an important role in determining the results.
This study seeks to solve an economic order quantity problem with quantity discount and proposed the economic order quantity with discount model optimization procedures and methods in solving the problem.
The next chapter is devoted for relevant literature on integrated inventory control and economic order quantity problems.
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