Customer ServiceAttacking the total cost of the

relationshipCosts of PurchasingCosts of ReceivingCosts of Ownership

Costs of Purchasing

Technical assistance in identifying the right product

Clerical assistance in reducing the cost of the transaction

Financing AssistanceTransportation Assistance

Costs of ReceivingAdvanced shipping

noticesScheduled arrivalPackaging

Costs of Ownership

Maintenance UpgradesAssociated services

Being in stock

Inventory availabilityShipping frequencyOrder cycle timeFill rates: The % of time orders (line

items) are filled as the customer requested

Service Level and Inventory

Time

Inve

ntor

y

Reorder Point

Lead Time

Lea

d T

ime

Dem

and

Ord

er Q

uant

ity

Service Level and Inventory

Time

Inve

ntor

y

Reorder Point

Safety Stock

Average Leadtime Demand

Inventory and Service Level

Average Inventory Level is 1/2 the Order Quantity plus The Safety Stock

The Safety Stock is Related to the service level or probability

leadtime demand does not exceed on hand stock.

Amount of stock you need to provide desired protection against variation in leadtime demand

Typical ModelNormal Distribution

0

0.0005

0.001

0.0015

0.002

0.0025

0.003

0.0035

0.004

0.0045

0 100 200 300 400 500 600 700 800 900

Leadtime Demand

Den

sity

Z

Probability Leadtime Demand is smaller

than z

Probability Leadtime Demand is larger

than z

Borden Foods Box 4.4 page 98Believe a 1% change in service level would

lead to a 0.1% change in sales volume$0.55 Trading Margin (Revenue - Direct Costs)

Std. Cost/Case: $5.38Annual Sales Volume: 59,904 cases Weekly Sales Volume: 1,152 casesStd. Deviation: 350 casesInventory Carrying Cost: 25% of Std Cost

Profit Calculation

Profit = Revenue - CostProfit =

Gross Revenue - Cost of Goods - Inventory Cost

Gross Revenue - Cost of Goods = Trading Margin * Sales Volume $0.55 * Sales Volume

Profit Calculation

Profit $0.55 * Sales Volume - Inventory Cost

Inventory Cost 25% of Std Cost * Inventory Volume 0.25 * $5.38/case = $1.345/case Inventory Volume =

Order Quantity/2 +Safety Stock

Profit Calculation

Profit $0.55 * Sales Volume - $1.345 * (Order Quantity/2 + Safety

Stock)How does Profit depend on Service

Level?

Service Level

Sales Volume “A 0.1% change in the [Sales Volume] … for

each 1% change in the service level” Sales Volume = (1+0.001*) * 59,904 cases is the change (in %) in the service level

Safety Stock Std Deviation * Normalized z(.99+ /100)

Typical ModelNormal Distribution

0

0.0005

0.001

0.0015

0.002

0.0025

0.003

0.0035

0.004

0.0045

0 100 200 300 400 500 600 700 800 900

Leadtime Demand

Den

sity

Current Safety Stock

.99 Probability Leadtime Demand is smaller

than Current Safety Stock

.01 Probability Leadtime Demand is larger

than Current Safety Stock

Typical ModelNormal Distribution

0

0.0005

0.001

0.0015

0.002

0.0025

0.003

0.0035

0.004

0.0045

0 100 200 300 400 500 600 700 800 900

Leadtime Demand

Den

sity

Current Safety Stock

.99 Probability Leadtime Demand is smaller

than Current Safety Stock

.01 Probability Leadtime Demand is larger

than Current Safety Stock

New Safety StockNew Service Level?

Optimum Service Level

Where incremental savings in Safety Stock balance incremental losses in Sales Volume

What makes this difficult?Relationship between Service Level and

Sales Volume (WAG)Relationship between Service Level and

Safety Stock (Normal Approximation)

The Balance

Impact of Changes in Sales Volume $0.55*0.001*59,904*(+d) = $32.95*(+d) Incremental effect is always $32.95 per 1%

Impact of Changes in Safety Stock $1.345*Incremental Change in Safety Stock $1.345*Std Dev. * Change in Normalized z

Have to work to get Change in Normalized z with Change in

Service Level (Look it up)

Using ExcelSafety Stock vs Service Level

300

400

500

600

700

800

900

0 0.02 0.04 0.06 0.08 0.1 0.12

Change in Service Level

Saf

ety

Sto

ck

The Formulas

Service Level Normalized Safety Stock Level Safety Stock Level0.99 0 =NORMINV(Service_Level,0,1) =350*Normalized_Safety_Stock_Level

Finding the new Service Level

Service Level

Safety Stock Level

Change In Safety

StockSafety Stock

ImpactIncremental Safety

Stock ImpactSales

Volume

Change in Sales Volume

Sales Volume Impact

Incremental Sales

Volume Impact

0.99 0 814 - -$ -$ 59,904 - -$ 32.95$ 0.98 0.01 719 (95) 128.32$ 128.32$ 59,844 (60) 32.95$ 32.95$ 0.97 0.02 658 (156) 209.74$ 81.42$ 59,784 (120) 65.89$ 32.95$ 0.96 0.03 613 (201) 270.99$ 61.25$ 59,724 (180) 98.84$ 32.95$ 0.95 0.04 576 (239) 320.81$ 49.82$ 59,664 (240) 131.79$ 32.95$ 0.94 0.05 544 (270) 363.22$ 42.41$ 59,604 (300) 164.74$ 32.95$ 0.93 0.06 517 (298) 400.40$ 37.18$ 59,545 (359) 197.68$ 32.95$ 0.92 0.07 492 (322) 433.69$ 33.29$ 59,485 (419) 230.63$ 32.95$ 0.91 0.08 469 (345) 463.97$ 30.28$ 59,425 (479) 263.58$ 32.95$ 0.9 0.09 449 (366) 491.84$ 27.87$ 59,365 (539) 296.52$ 32.95$

0.89 0.1 429 (385) 517.74$ 25.90$ 59,305 (599) 329.47$ 32.95$ 0.88 0.11 411 (403) 542.00$ 24.26$ 59,245 (659) 362.42$ 32.95$ 0.87 0.12 394 (420) 564.88$ 22.88$ 59,185 (719) 395.37$ 32.95$

Why is the incremental Safety Stock Impact decreasing?Why didn’t we do this in terms of Safety Stock?

Was this meaningful?

Inventory Effect Reduced Inventory by about 300-350 cases Saved about $400-$450 in carrying cost

Sales Volume Effect Reduced Sales Volume by 350-450 cases Lost $200 - $250 in revenue

Net Effect: Approximately $200 per year

Customer Service

Preparing for ContingenciesYour contingenciesYour suppliers’ contingenciesYour carriers’ contingenciesYour customers’ contingenciesYour competitors’ contingencies