Cutting Inventory and Operating Costs

Once you do whatever you feel you have to do to make your supply chains simulation run for 30 days the next challenge is to keep your supply chain running but now do it with the lowest cost in inventory and operating expenses. As you strive to reach this goal, you will experience the classic quandaries that all supply chain managers encounter.

There are many trade-offs to consider; some work better than others. You will learn by trial and error, and there will be some frustration along the way to finding out what works. Yet whatever happens, you will start speaking and thinking like a real supply chain manager as you describe your problems and discuss possible solutions.

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Remember, what works in these simulations will also work in the real world to manage actual supply chains. SCM Globe is not just a game. Successful techniques you discover here can be applied to fix similar supply chain problems at your company.

These ideas listed below apply to all of the case studies and to any supply chain you design on your own. If you keep trying different ideas and looking at the simulation results, you will see patterns and relationships between different entities in the supply chain. It may be frustrating at first, but there will be an “Aha!” moment if you keep at it. Here are some things to consider:

Look at the simulation data and notice where excess inventory builds up. Think of ways to reduce the excess inventory. You can do this by scheduling product deliveries to better match product demand. And if the simulation starts out with too much product on-hand at a facility, then schedule deliveries that deliver less than the demand amount so the excess inventory will be used up at the facility.

Think about ways to use just-in-time delivery of inventory to stores and warehouses to prevent buildup of excess inventory. Try to schedule your delivery vehicles so they deliver inventory to cover demand and replenish safety stock and no more. You can make smaller deliveries to every store every day or you can deliver larger amounts every few days. Experiment with using different size trucks that go at different speeds and carry different volumes of products. You can use the default values or do research on the Internet to find truck size, speed and cost numbers. Use your best estimates for these numbers. See explanation below of how to use the Economic Order Quantity (EOQ) to calculate optimal product delivery amounts and frequencies.

Experiment with multi-stop delivery routes versus single stop delivery routes and look at the vehicle expenses involved. If several stores are relatively close to each other and a truck can carry enough inventory, then it’s probably better to use multi-stop routes. If stores are spread out and not close to each other then it might be better to do single drop routes. Run simulations of different ideas and see what happens.

Look at the rent costs of the facilities. How much storage space do you really need at each facility? If you reduce on-hand inventory at facilities then you can also reduce the amount of storage space needed and the daily rent paid on that storage space.

When you open new stores or warehouses look for locations that are near good transportation routes such as major highway intersections. This will reduce travel times and transportation costs.

Consider using rail transport when rail connections are available. Rail roads are a much less expensive way to move inventory than using trucks. Do research on the websites of major rail carriers and see where their rail lines go and see if you can locate stores or warehouses nearby. (Notice in the Cincinnati Seasonings case study the factory is located right near a major rail yard in Cincinnati). Consider opening a new DC to support company growth and new stores and locate that DC near a rail yard so you can ship product to the new DC from the factory using rail transport. And the DC can also use rails to ship to stores that are farther away than what a truck could reach in a few hours or less.

Transportation by ship or barge is also much less expensive than by truck or airplane. Are your facilities located near large bodies of water or rivers or canals where you can transport products using ships or barges? Does it make sense to use this type of transportation for your products?

  ECONOMIC ORDER QUANTITY (EOQ) for Delivery Amounts and Frequencies

Estimate product delivery amount (drop qty) and delivery frequency at each stop on a route by using:

  • Daily demand for product at a facility
  • Economic order quantity (EOQ) for a product at a facility

Daily demand for a product at a store (or aid facility in disaster response supply chain) is estimated by the number of people served by the facility multiplied by the amount of that product needed per person per day. In supply chain models for case studies in the SCM Globe library there are default daily demand numbers already provided.

EOQ is a way to calculate product order size so it minimizes the cost of ordering and holding a product in inventory at a facility. Here is the equation (means square root):
EOQ = √ 2 x (annual product demand) x (ordering cost) / (annual holding cost)

The EOQ equation tells you how much to deliver to a facility because you can assume that amount is what the facility ordered. Set product delivery amount (drop qty) at a facility to the EOQ amount for the product at that facility. Divide EOQ by daily demand for the product to estimate how often deliveries should be made – see example below. 

Determine delivery amounts and frequencies at stores first, then work backward to determine amounts and frequencies of deliveries from factories to warehouses that support store deliveries (remember there is no product demand at warehouses unless the product is actually consumed at a warehouse).

EXAMPLE – Estimating assumptions:

  • Product A is a pallet sized quantity of product and has a price of $500
  • Store (or aid facility) serves 1000 people, demand is one tenth (0.1) of a pallet per person per day for Product A
  • Therefore, demand at store for Product A is: 1000 x 0.1 = 100
  • Ordering cost for Product A is $30 (see more about ordering cost in Notes below)
  • Annual holding cost for Product A is 20% of its price: 0.2 x 500 = $100

EOQ = 2 x (annual product demand) x (ordering cost) / (annual holding cost)

EOQ =   2 x (100 x 365) x $30 / 100

        = 21,900

        = 147.98 (square root of 21,900)

        so delivery amount or drop qty is about 148

To minimize on-hand inventory at a facility, set delivery frequency for a facility to equal the product drop qty divided by product daily demand at that facility:

  • 148/100 = 1.48 days
  • delivery frequency is controlled by the number of hours in the “Delay between Departures” field at the bottom of the edit box for vehicles
  • 1.48 days x 24 = 35.52 hours
  • delay between departures: 35.52 minus route travel time
  • so if route travel time is 6.5 hours (route times should be round-trip but sometimes show one-way; see Bug 2 in the FAQs Bug Report) then set delay between departures to be 35.52 – 6.5 or about 29 hours


  • Ordering Cost is an estimate of how much it costs an organization to place an order, receive the order, issue payment and put away the inventory delivered. Different companies have different ordering costs; estimates can range from $15 to $150 or more. Industry trade associations can provide data on average ordering costs for companies in their industries, or your company may already have an ordering cost it uses for EOQ calculations.
  • Estimates ranging from $30 to $60 for ordering costs are common in many companies (use $30 if you are working on the Cincinnati Seasonings case study).
  • Annual holding costs are often estimated at 20% of product price. Industry trade associations can provide data on average holding costs for companies in their industry.
  • EOQ amounts are affected by estimates for ordering cost and annual holding cost.
  • Different facilities will have different delivery amounts and frequencies for different products – so group facilities with similar needs into common routes when possible.
  • Delivery amounts are constrained by size and weight capacity of delivery vehicles.
  • Use simulation results to adjust these initial estimates as needed to fix problems so supply runs for desired length of time (usually 15 – 30 days).
  • See further explanation of EOQ here
  • And here is a short slide presentation explaining EOQ from a professor at the University of Texas at Dallas

Look at overall demand for products at the stores and  synchronize factory production to meet store demand. If you produce more products than the stores demand there will be accumulation of excess inventory at one or more facilities in the supply chain. If you do not produce enough inventory then one or more stores will run out of inventory unless your simulation starts with large amounts of inventory already on-hand at facilities.

This supply chain planning worksheet shown below was designed by a student team in Dr. Dennis Duke’s graduate supply chain management class at Florida Institute of Technology. It is an example of how to plan and synchronize product production and deliveries to meet product demand.

(click on image for bigger picture)Supply-Chain-Plng-Worksheet2

These are a few ideas to try. As you play with different ideas and simulations you will start to get an intuitive feel for what works. There is no single answer that fits every situation so different techniques work best in different situations. Supply chains are part science and part street smarts, and professionals who learn to combine the science and the street smarts are much in demand.


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