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Inventory Management I:

Inventory Management I


Definitions Inventory- A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. Inventory System - A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be


Inventory Def. - A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. Raw Materials Works-in-Process Finished Goods Maintenance, Repair and Operating (MRO)

Expensive Stuff:

Expensive Stuff The average carrying cost of inventory across all mfg.. in the U.S. is 30-35% of its value. What does that mean? Savings from reduced inventory result in increased profit.

Zero Inventory?:

Zero Inventory? Reducing amounts of raw materials and purchased parts and subassemblies by having suppliers deliver them directly. Reducing the amount of works-in process by using just-in-time production. Reducing the amount of finished goods by shipping to markets as soon as possible.

Inventory Positions in the Supply Chain:

Inventory Positions in the Supply Chain Raw Materials Works in Process Finished Goods Finished Goods in Field

Reasons for Inventories:

Reasons for Inventories Improve customer service Economies of purchasing Economies of production Transportation savings Hedge against future Unplanned shocks (labor strikes, natural disasters, surges in demand, etc.) To maintain independence of supply chain

Inventory and Value:

Inventory and Value Remember this? Quality Speed Flexibility Cost

Nature of Inventory: Adding Value through Inventory:

Nature of Inventory: Adding Value through Inventory Quality - inventory can be a “buffer” against poor quality; conversely, low inventory levels may force high quality Speed - location of inventory has gigantic effect on speed Flexibility - location, level of anticipatory inventory both have effects Cost - direct: purchasing, delivery, manufacturing indirect: holding, stockout. HR systems may promote this-3 year postings

Nature of Inventory: Functional Roles of Inventory:

Nature of Inventory: Functional Roles of Inventory Transit Buffer Seasonal Decoupling Speculative Lot Sizing or Cycle Mistakes

Design of Inventory Mgmt. Systems: Macro Issues:

Design of Inventory Mgmt. Systems: Macro Issues Need for Finished Goods Inventories Need to satisfy internal or external customers? Can someone else in the value chain carry the inventory? Ownership of Inventories Specific Contents of Inventories Locations of Inventories Tracking

How to Measure Inventory:

How to Measure Inventory The Dilemma : closely monitor and control inventories to keep them as low as possible while providing acceptable customer service. Average Aggregate Inventory Value: how much of the company’s total assets are invested in inventory? Ford:6.825 billion Sears: 4.039 billion

Inventory Measures :

Inventory Measures Weeks of Supply Ford: 3.51 weeks Sears: 9.2 weeks Inventory Turnover (Turns) Ford: 14.8 turns Sears: 5.7 turns GM: 8 turns Toyota: 35 turns

Reasons Against Inventory:

Reasons Against Inventory Non-value added costs Opportunity cost Complacency Inventory deteriorates, becomes obsolete, lost, stolen, etc.

Inventory Costs:

Inventory Costs Procurement costs Carrying costs Out-of-stock costs

Procurement Costs:

Procurement Costs Order processing Shipping Handling Purchasing cost: c(x)= $100 + $5x Mfg. cost: c(x)=$1,000 + $10x

Carrying Costs:

Carrying Costs Capital (opportunity) costs Inventory risk costs Space costs Inventory service costs

Out-of-Stock Costs:

Out-of-Stock Costs Lost sales cost Back-order cost

Independent Demand:

Independent Demand Independent demand items are finished products or parts that are shipped as end items to customers. Forecasting plays a critical role Due to uncertainty - extra units must be carried in inventory

Dependent Demand:

Dependent Demand Dependent demand items are raw materials, component parts, or subassemblies that are used to produce a finished product. MRP systems---next week

Design of Inventory Mgmt. Systems: Micro Issues:

Design of Inventory Mgmt. Systems: Micro Issues Order Quantity Economic Order Quantity Order Timing Reorder Point

Objectives of Inventory Control:

Objectives of Inventory Control 1) Maximize the level of customer service by avoiding understocking. 2) Promote efficiency in production and purchasing by minimizing the cost of providing an adequate level of customer service.

Balance in Inventory Levels:

Balance in Inventory Levels When should the company replenish its inventory, or when should the company place an order or manufacture a new lot? How much should the company order or produce? Next: Economic Order Quantity

Models for Inventory Management: EOQ:

Models for Inventory Management: EOQ EOQ minimizes the sum of holding and setup costs Q = 2DC o /C h D = annual demand C o = ordering/setup costs C h = cost of holding one unit of inventory


Seatide EOQ = 2DC o /C h D = annual demand = 6,000 C o = ordering/setup costs = $60 C h = cost of holding one unit of inventory $3.00 x 24% = .72 2 x 6,000 x 60 .72 720,000 .72 1,000

Marginal Analysis:

Holding Costs Ordering Costs Marginal Analysis Units $

Reorder Point:

Reorder Point Quantity to which inventory is allowed to drop before replenishment order is made Need to order EOQ at the Reorder Point: ROP = D X LT D = Demand rate per period LT = lead time in periods

Slide 28:

level of inventory average inventory units Q t time Sawtooth Model

Q - System Inventory Control:

based on reorder point - When inventory is depleted to ROP, order replenishment of quantity EOQ. Q - System Inventory Control

Order Quantities:

when demand is smooth and continuous, can operate response-based system by determining best quantity to replenish periodic demand (EOQ) frequency of replenishment (ROP) Reorder Point Order Quantities

Planning for Uncertainty:

changing lead times changing demand Uncertainty creeps in: Plug in safety stock Safety stock - allows manager to determine the probability of stock levels - based on desired customer service levels Planning for Uncertainty

Inventory Model Under Uncertainty:

Inventory Model Under Uncertainty reorder Q m point safety stock time

Models for Inventory Management: Quantity Discount:

Models for Inventory Management: Quantity Discount Basically EOQ with quantity discounts To solve: 1. Write out the total cost equation 2. Solve EOQ at highest price and no discounts 3. If Q min falls in a range with a lower price, recalculate EOQ assuming holding cost for that range. Call this Q 2 . 4. Evaluate the total cost equation at Q 2 at the next highest price break point. OR Use a spreadsheet

P-System Periodic Review Method:

an alternative to ROP/Q-system control is periodic review method Q-system - each stock item reordered at different times - complex, no economies of scope or common prod./transport runs P-system - inventory levels for multiple stock items reviewed at same time - can be reordered together higher carrying costs - not optimum, but more practical P-System Periodic Review Method

Using P-System:

audit inventory level at interval (T) quantity to place on order is difference between max. quantity (M) and amount on hand at time of review management task - set optimal T and M to balance stock availability and cost In ABC analysis, which items would use P-system??? Using P-System

Types of Inventory Systems:

Types of Inventory Systems By Degree of Control required often use grouping method, such as ABC

Classifying Inventory Items:

Classifying Inventory Items ABC Classification (Pareto Principle) A Items: very tight control, complete and accurate records, frequent review B Items: less tightly controlled, good records, regular review C Items: simplest controls possible, minimal records, large inventories, periodic review and reorder

Does ABC Classification Make Sense for an Assembler?:

Does ABC Classification Make Sense for an Assembler? i.e. – Gateway Computers

Slide 39:

Planning Supply Chain Activities Anticipatory - allocate supply to each warehouse based on the forecast Response-based - replenish inventory with order sizes based on specific needs of each warehouse

Anticipatory Inventory Control:

determine requirements by forecasting demand for the next production run or purchase establish current on-hand quantities add appropriate safety stock based on desired stock availability levels and uncertainty demand levels determine how much new production or purchase needed (total needed - on-hand) Anticipatory Inventory Control

Response-Based System:

replenishment, production, or purchases of stock are made only when it has been signaled that there is a need for product downstream requires shorter order cycle time, often more frequent, lower volume orders determine stock requirements to meet only most immediate planning period (usually about 3 weeks) Response-Based System

Slide 42:

Service Level Achieved 1- expected number of units out of stock/year total annual demand Item fill rate (IFR): the probability of filling an order for 1 item from current stock Weighted Average Fill Rate ( WAFR): multiply IFR for each stock item on an order weighted by the ordering frequency for the item

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